The news of the United States and Iran getting closer to a deal to end the West Asia hostilities, which intensified from February 28 this year, has had a calming effect on the markets, raising hopes of the reopening of the Strait of Hormuz, through which a fifth of global trade in oil takes place. This optimism is understandable.
Prices of crude oil have declined. Stock prices have bounced back. Hopefully, the agreement will be signed by June 19 and talks over the following two months will give a final workable shape to the agreement. The global energy situation will still take a few more months to return to relative stability or even to the point that prevailed before the hostilities began. But the crisis is not getting worse and it indeed appears to be getting over.
In India, the rupee has gained against the dollar. Bond yields have come down a bit. The steps taken by the Union government and the Reserve Bank of India recently have raised prospects of an increased flow of foreign exchange through overseas deposits and foreign investment in bonds. These steps should address concerns over a widening deficit in the balance of payments even as the tasks of managing the resultant liquidity rise through open-market operations or an increase in cash reserve ratio could become more urgent.
The Indian Basket crude oil prices, something which impacts the processing cost of India’s oil refineries, is on the decline after staying in the range of $106-114 a barrel in March, April and May. This was a sharp increase from the average price of $63 in January and $69 in February. The Indian Basket crude oil price has declined to $83 a barrel after the US-Iran peace deal news broke this Monday.
Underrecoveries of India’s state-controlled oil refineries have also declined — to Rs 3 per litre for petrol and Rs 27 per litre for diesel. Before the increase in the retail prices of petrol and diesel in May in four tranches, the underrecovery, or the gap between the refining cost and the retail price, had risen to Rs 24 per litre for petrol and about Rs 105 per litre for diesel. Fears of a runaway retail inflation rate are on the wane as the government will think twice before effecting the next round of increase in prices of petroleum products.
Managers of the Indian economy in the government and the central bank should be heaving a sigh of relief. This too is understandable.
What, however, will not be understandable is if the government’s approach to dealing with the challenges that the Indian economy faces, going forward, is marked principally by celebrating the economy’s resilience and complacency that the crisis has been resolved. Far from resolving the crisis, the challenges that lie ahead continue to be as formidable, if not more, as they were before the crisis had surfaced. The economy may have the resilience to withstand a shock of this nature, but complacency arising out of that feeling should not be allowed to dilute the government’s focus on what policy correctives need to be applied without any further delay. There are at least two immediate priority steps that the government must focus on in the current situation.
One, the oil sector needs continued attention. A tripartite agreement among Assam, Nagaland and the Union government on expeditious drilling in oil reserves in the Northeast, which accounts for more than 22 per cent of the country’s crude-oil reserves and 15 per cent of gas reserves, should be seen just as the beginning of a long necessary journey ahead.
The sobering reality is that India’s dependence on imports of crude oil has gone up from 84 per cent (of its consumption) in 2014-15 to 90 per cent in 2025-26. Of course, a growing economy led to a higher demand for crude oil, but what contributed to the rising import dependence was a steep decline in domestic production in this period — from 36 million tonnes in 2014-15 to 26 million tonnes in 2025-26. The import of natural gas too has gone up, with its share in domestic consumption increasing from about 40 per cent to over 50 per cent during the same period.
The government did roll out new policies to boost domestic output. They yielded some results in gas production, but oil production maintained a southward direction in spite of a policy switchover from a cost-recovery-based New Exploration Licensing Policy (NELP) to a more investor-friendly Hydrocarbon Exploration and Licensing Policy. Recent initiatives by the petroleum ministry in encouraging greater use of ethanol-based fuel for vehicles are welcome, but it should also step up its drive to increase the domestic production of crude oil and gas with equal zeal.
Two, there are reasons to be worried about the available fiscal space with the government, with the additional annualised burden of expenditure on account of the various steps taken in the wake of the West Asian crisis going up to about Rs 4 trillion. These include an extra burden of Rs 1 trillion on account of the cut in special additional excise duty on petrol and diesel, an allocation of Rs 1 trillion for the Economic Stabilisation Fund, an additional fertiliser subsidy burden of Rs 1.7 trillion, and an allocation of Rs 18,000 crore for the credit guarantee scheme for micro, small and medium enterprises. If not matched by expenditure savings under some other heads, the additional spending burden would widen the fiscal deficit of the Union government to about 5.3 per cent of gross domestic product (GDP) as against the budgeted figure of 4.3 per cent. The need, therefore, is to either raise revenues through taxation measures or take some other steps.
In order to soften the impact of higher prices of crude oil on oil companies, as they could not raise retail prices, the Union government on March 26 cut special additional excise duty on petrol and diesel by Rs 10 a litre, a move that implied an annualised revenue loss of Rs 1 trillion in 2026-27. As the international crude oil prices decline, the Union finance ministry should roll back the cut in special additional excise duty and reduce the hit on the fisc.
The bill for fertiliser subsidies was feared to double from the budgeted Rs 1.7 trillion to Rs 3.4 trillion. Experts found this projection an underestimate because the fertiliser department in the government had asked for a much higher allocation, even as there were pleas from various arms of the government to prevent diversion and institutionalise the linkage of subsidy allocation to the farmers’ landholding through digital means. The initial steps taken in this direction should be expedited to reduce the subsidy bill and more measures should be taken to use the direct benefit transfer mechanism for paying the subsidy directly to the farmers.
Between 2014-15 and 2025-26, the annual average Indian Basket crude oil price hovered between $46 and $93 a barrel, with six of these years recording a decline in the annual average price over the previous year. However, that period of relatively modest prices was not exploited for effecting policy fixes to reduce the subsidy burden on the fisc or improve self-sufficiency in oil. The expected softening of international crude oil prices in the coming months should not again lull the government into policy inertia or inaction.
AK Bhattacharya is the Editorial Director of Business Standard. He tweets @AshokAkaybee. Views are personal.