Ind-Ra: Diesel Price Decontrol May Create More Policy Space for RBI

India Ratings & Research (Ind-Ra) says the union government's decision to deregulate diesel prices will significantly improve the country's finances as the oil subsidy will come down by INR150bn. Also, the cut in diesel prices by INR3.56/litre will go a long way in fighting inflation, which is trending downwards. This will create more space for the Reserve Bank of India to ease its policy stance and cut policy rate sooner than hitherto believed.

Ind-Ra on 1 September 2014 expressed its view in favour of decontrolling diesel prices at the earliest. The staggered diesel price hike initiated since January 2013 and the recent decline in the prices of crude in the global market have converted the under recovery of public sector oil marketing companies into an over recovery. The over recovery on diesel for such companies reached INR3.56/litre for the second fortnight of October. The crude price of the Indian basket as on 15 October 2014 fell to USD83.85/bbl and the currency was at INR61.1/USD. When diesel prices were increased by around INR5/litre on 14 September 2012, the Indian crude oil basket was priced at USD113.64/bbl and the currency was at INR55.47/USD, leading to an under recovery of INR13.86/litre.

Although the rupee depreciated to around 61.5/USD by the middle of October 2014 from around 59/USD in May/June 2014, the sharp fall in the global crude prices has overall lowered the import price of Indian basket considerably. As the crude prices in the global market are likely to remain low in the near term due to the US' discovery of shale oil as also the struggling economies of Europe and Asia, deregulating diesel prices is both the right and opportune step.

However, India will have to be watchful of global developments. Crude prices and therefore petroleum product prices are currently low because of low demand and appreciation of the US dollar in relation to its trading partners (measured by US Dollar index). In a scenario where even if global oil and petroleum products demand and supply remain same, depreciation of the US dollar may flare up both crude and product prices. Although the fuel price deregulation was scheduled to begin from April 2002, it took more than 12 years to deregulate petrol and diesel prices. The present order is however silent on government intervention in the eventuality of global prices flaring up again.

Currency movement (INR/USD) also has a significant impact on petroleum product prices and subsidy. Ind-Ra expects the rupee to strengthen marginally and this will have a favourable impact both on petroleum product prices and subsidy.

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