Oil’s not well

The relentless 3-month rise in the price of crude oil has brought it to the threshold of the psychologically critical $100/barrel mark. On Tuesday, the Indian basket of crude was priced at $95.6/barrel, with the monthly average price increasing 24% since June. The cause for this price surge is cartelisation. IEA forecast global oil demand this year will be 102.2 million barrels per day, an increase of 2 million a day. This moderate rise in demand has been exploited by the oil cartel OPEC+, led by Saudi Arabia and Russia, through a deliberate cut in output.

The situation’s unlikely to change soon and crude price will remain elevated. Usually, the immediate impact of a price surge is on inflation. However, in India the effect will be muted for now as GOI has frozen retail pump prices for about 16 months and cut cooking gas prices. This does not mean India is insulated from international crude price trends. Its impact will play out through three channels.

First, the impact will be felt through increased input costs of manufacturers. Second, there will be upward pressure on interest rates in money markets. Third, with election season upon us, governments and political parties will be tempted to abandon fiscal restraint to mitigate cost of living pressures. Of the three channels, the last two are interrelated and have a stronger impact on the trajectory of inflation and economic growth. The situation calls for careful management by RBI and governments at all levels. RBI has put on hold its policy of monetary tightening that led to an increase in its policy interest rate by 2.5 percentage points since May 2022. This, in turn, led to an increase of 1.93 percentage points, till July 2023, in the weighted average lending rate of fresh rupee loans.

Breaking down the factors driving inflation, food prices are the main trigger this year. Neither food nor fuel price increases can be dealt by increasing interest rates directly or indirectly through liquidity measures. RBI should not immediately respond to the crude price surge, but the central bank needs to be supported by an appropriate fiscal stance. GOI and major states this year have stepped up investment. They need to persist as private firms right now may hold back. Therefore, governments need to maintain both fiscal restraint and stick to the current spending pattern to see through this phase.

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