Vehicle owners in India are inured to the prices of petrol and diesel changing on a daily basis, as oil-marketing companies adjust their prices to reflect changes in international crude prices. However, retail prices of fuels were frozen between April 24 and May 13, while campaigning was on in the Karnataka Assembly elections. There was a similar freeze before the Gujarat Assembly elections in December.

Crude prices have not been entirely stable during this period. On April 20, the benchmark spot Brent contract traded at $74.62 a barrel. By May 9, it had spiked to above $77, as the US re-imposed sanctions on Iran, a major oil exporter. This was the highest price of crude since late 2014, and normally, that swing of 3.2% would have been reflected in similar price hikes at petrol pumps. Indeed, when retail prices were changed on May 13, diesel hit all -time highs while petrol went back to levels not seen since 2014.

The government is the majority shareholder in the oil-marketing companies that dominate the retail fuels market. The oil public sector undertakings – Bharat Petroleum Corporation, Hindustan Petroleum Corporation, Indian Oil Corporation and the Oil and Natural Gas Corporation – control around 85% of India’s pump network. So the government can implement a price freeze without overt changes in policy.

However, whatever the political justifications may be, freezing retail prices for any sustained period is not an optimal way to operate a refining-retailing business. Crude and gas prices fluctuate minute to minute and oil-marketing companies can lose vast sums if they are not allowed to pass on rising costs. There are estimates that the oil-marketing companies lost between Rs 1500 crore to Rs1700 crore during the freeze.

All about crude

A price rise can stress out multiple macro-economic variables. India imports 82% of its crude, and about 30% of its gas. Crude is, by far, the largest import item.

If crude prices rise, so does the import bill. That skews the trade balance (physical exports minus physical imports) leading to a larger trade deficit. More broadly, it skews the current account (exports of goods and services minus imports; payments received from abroad minus payouts to foreign entities, net remittances and so on), leading to a current account deficit. The rupee comes under pressure and a weaker rupee means other imports become more expensive.

When crude prices are low, the government can allow retailers to set prices and keep a profit margin. It can also impose high taxes on petrol, diesel and aviation turbine fuel. Roughly 55% of the retail price of these fuels consists of taxes levied by the Centre and by state governments. It is a win-win when the oil-marketing companies make profits and the government collects taxes.

High prices create lose-lose situations. Fuel prices are politically sensitive. If the government allows retailers to pass on costs and maintain profit margins, there is an inflationary effect. If it imposes high taxes, prices go even higher. If it freezes low prices, oil companies lose money and need subsidies. If taxes are cut, it collects less revenue.

In addition, the government funds subsidies for kerosene, cooking gas and fertiliser. These all become more expensive if crude prices rise. Plus, the railways has to consider hiking politically sensitive fares and freight charges.

Good days over

The Indian crude basket is linked to Brent, along with a couple of other grades of crude. The ruling Bharatiya Janata Party was lucky in that crude prices dropped in September 2014 and stayed low for three years. That situation has changed, and there may be macro-economic stresses in store.

The Congress-led United Progressive Alliance dealt with high prices for several years.

Only April 2018 data used for 2018-2019.

The Indian crude basket cost an averaged $111.89 per barrel in 2011-’12, $107.97 (2012-’13) and $105.5 (2013-’14). In September 2014, prices started falling. The average price in 2014-’15 was $84. In 2015-’16, it dropped to $46.17. In 2016-’17, it stayed low at $47.56. In 2017-’18, it rose appreciably to $56.42. In April, the basket cost $69.3 per barrel and May will be even higher. The rupee has also plunged, from Rs 63.67 on January 29 to Rs 68.04 on May 16.

The United Progressive Alliance did not deal well with high prices. No Indian government has. It froze retail prices and created oil bonds as a system to compensate oil-marketing companies for losses (known as “under-recoveries”). It also forced public sector fuel-producers such as the Oil and Natural Gas Corporation and Oil India to sell crude and gas at a subsidised rate to public sector oil-marketing companies.

Expensive crude and gas imports was the primary reason for a high current account deficit through 2011-’12 to 2012-’13. The rupee depreciated sharply, hitting a low in September 2013, as Raghuram Rajan took charge at the Reserve Bank of India. Rajan took a series of emergency measures and in 2013-’14, the current account deficit started to come down. It stayed down until 2016-’17. In 2017-’18, the current account deficit is estimated at 1.8% of gross domestic product (the total value of goods produced and services provided in a country during one year). If the crude basket costs an averaged $65 per barrel in 2018-’19, the current account deficit will hit 2.4% of the gross domestic product, according to projections from Kotak Research. The current account deficit could climb considerably higher if crude prices run higher.

During the United Progressive Alliance regime, a policy of retail price freeze coupled with the oil bond subsidy contributed to the fiscal deficit (the difference between the total revenue of the government and its expenditure) as well.

The reduction in the fiscal deficit during the first three years of the BJP government was certainly helped along by low crude prices.

Ballooning fiscal deficit

Crude prices are likely to stay high through the current financial year. The Organisation of Petroleum Exporting Countries, or OPEC, led by the Saudis, have hammered out an agreement to cut crude production to push prices up. Russia, which is the world’s largest non-OPEC oil exporter was on board with that production cut. US President Donald Trump’s decision to re-sanction Iran could also take a large oil exporter out of the equation, constraining supply even more. The US shale industry will compensate by ramping up production. But a large proportion of shale production is not profitable below $55-$60 per barrel and the US has issues about oil exports. So there is a floor on crude prices.

In 2017-’18, the government missed its fiscal deficit targets. This is an election year, and we have already seen how seriously the Modi government takes elections. It is unlikely that government spending will be curtailed in an election year.

If crude prices do stay high, the government will have a serious policy problem. Does it maintain fiscal prudence by allowing fuel prices to rise, and thereby risk angering voters? Does it freeze prices and accept a ballooning fiscal deficit?