Clouded outlook: Policymakers need to remain agile in current environment

The United States, according to reports, has rejected the latest proposal sent by Iran to end the stalemate. This means the uncertainty in West Asia continues with no clarity as to when the blockade in the Strait of Hormuz will be lifted and when oil and gas will resume their flow. Nearly one-fifth of global crude oil passes through the strait. Since not much has flowed through this route from the time of the beginning of the conflict on February 28, global prices of crude oil remain elevated. Higher prices are creating difficulties in most parts of the world, including India. After much delay, state-run oil-marketing companies (OMCs) have started adjusting pump prices. In cases of a sudden spike in prices of crude oil, governments often face the dilemma of whether to absorb the increase or pass it on to consumers. An analytical post published by the International Monetary Fund on Wednesday offers some policy insights. 

It rightly notes that there is no one-size-fits-all response. The impact of the conflict in West Asia depends on, among other things, energy dependence, market structure, and fiscal space. Sustained higher prices can affect households’ purchasing power and strain businesses. However, if the government response is not designed carefully, it can prove costly and difficult to unwind. Thus, the fiscal response needs to be temporary, timely and targeted. It suggests that domestic energy prices be allowed to reflect the costs. Vulnerable households can be provided temporary and targeted support, while viable small businesses can be supported through liquidity measures and not price controls. In India, the government has announced a credit-guarantee scheme to support businesses, along with a special arrangement for airlines. However, it has not allowed domestic prices to reflect the international costs. It has reduced the special additional excise duty, which will directly hit its Budget arithmetic. 

Until recently, OMCs were reported to be facing underrecoveries worth ₹1,000 crore per day. After two modest increases in petrol and diesel prices, they have come down, but more needs to be done because the losses of the OMCs will ultimately hit government finances. The suggestion to support vulnerable households is more difficult to implement in the Indian context because of targeting issues. Measuring the extent to which a household is affected will be difficult, and it could easily become a political issue. For instance, the government provides free food grain to over 800 million people, which is hard to justify. Besides, the government is protecting farmers, and arguably consumers as well, by not allowing fertiliser prices to adjust. 

Thus, overall, there are no easy answers in terms of managing the situation. Nevertheless, the government needs to allow greater price adjustment because the situation could worsen further. Analysts argue that the price impact of the Iran conflict has thus far been muted because countries have been running down their reserves. But that cannot last very long. As a result, prices may increase substantially in the coming weeks, and the availability of oil and gas could become an issue if the conflict isn’t resolved quickly. Therefore, Indian policy managers have to remain agile in responding to the situation. A combination of price adjustment, fiscal support, and supply management may need to be adopted for all fuel categories. At a broader level, the world is paying the price for a fractured global governance system in which some countries can unilaterally start wars and hold the entire global economy hostage without facing any consequences.