For every $10 per barrel increase in oil price, inflation in India rises by about 49 basis points (bps), or pushes up the fiscal deficit by 43 bps, if the government decides to absorb the entire price shock, according to a staff study of the Reserve Bank of India (RBI).
One basis point is a hundredth of a percentage point. The study, although not an official document of the central bank, assumes significance in the wake of the significant flip flop in oil price and the policy challenges it introduces. The researcher duo, Saurabh Ghosh and Shekhar Tomar, of the RBI’s Strategic Research Unit, showed that that an increase in crude price worsens the current account deficit (CAD) to an extent that cannot be compensated through a higher gross domestic product (GDP) growth. This leads to a higher CAD to GDP ratio.
International crude prices started climbing from April last year, and by September, it had reached $86 a barrel, from $67 a barrel at the start of the financial year. The prices again started cooling off in November, and now is trading at less than $60 a barrel.
However, the prices could flare up again as trade war concerns and geopolitical tensions continue in West Asia. Then RBI governor Urjit Patel had acknowledged the difficulties in inflation prediction and policy making in the context of a volatile oil price.
“Under the most conservative estimate, we quantify that a $10/barrel increase in crude price at the price of $65/barrel will lead to a 49 basis points (bps) increase in headline inflation. A similar increase at $55/barrel gives around a 58 bps increase in headline inflation. Third, if the government decides upon a zero pass-through to the final consumers, a $10/barrel increase in the crude prices could increase the fiscal deficit by 43 bps,” the staff paper said.
The final impact on the inflation and fiscal deficit would depend on the level of government intervention (changes in tax and subsidy) in the domestic oil market, said Ghosh and Tomar.
“These results suggest that the crude price shock will continue to be a cause of concern on both domestic and external fronts in the foreseeable future,” the paper said.
According to the worst-case scenario, assumption of the paper, when crude prices hit $85 a barrel, the deficit on account of oil would be $106.4 billion, which is 3.61 per cent of India’s GDP. Every $10 per barrel increase in crude prices leads to an additional $12.5 billion deficit — roughly 43 bps of India’s GDP.
Similarly, every 100 bps increase in petrol price would lead to 2.6 bps increase in core CPI index. “Since a $10/barrel increase roughly translates to 1,000 bps increase in pump prices (at crude price $65/barrel), it could increase core inflation by 26 bps and overall CPI inflation by 12.5 bps (core is 47 percentage of total CPI),” the paper said.
The volume of crude imports has been rising steadily at around 4.5 per cent per annum for India, according to the paper.
“In value terms, crude is the single-largest import contributor, and has consistently accounted for more than 20 per cent of India’s imports basket. Since India imports most of its crude, it is susceptible to global crude price shocks,” it said.
However, currently, around one-third of these imports are re-exported after refining and other value additions. There is a complete pass-through of raw crude prices into re-exports as their demand is also inelastic, according to the researchers.