Could the oil prices be any higher?

Recently, fuel prices in India have been setting new records each day. Since January 2021, petrol prices have been hiked by ₨.10.8 while diesel prices have risen by Rs.11.5 in the same period. As of June, in as many as 11 states petrol prices have crossed the Rs.100 mark and are showing no inclination to fall even a little bit. Such a steep hike has been troubling both, the Indian government and citizens, and everyone is asking the same question, is this rise temporary? 

I try to address this question in the article by exploring the reasons for this hike, the government’s role in it, and using the reasons to try to foreshadow few possibilities about fuel prices in the future.

Why are the fuel prices high? 

One of the major reasons is the rise in crude oil prices. Since January 2021, prices of crude oil have been constantly rising in the whole world. That’s because OPEC(The Organization of the Petroleum Exporting Countries) has extended the supply cuts it imposed in 2020. The move to reduce the supply of crude oil became a necessity for the last year as due to worldwide lockdown, the oil demand reduced drastically, resulting in a record fall in crude oil prices, causing huge losses for them. However, as the effects of Covid started to dissipate and the economies became operational again, the demand for crude oil started increasing. Yet the OPEC nations decided to further reduce their supply of crude oil. This resulted in a huge gap between the demand and supply of oil and so, the prices started increasing as well. Since India imports, 80% of its total fuel consumption, this rise in crude oil price affects them.

This is not the only reason why Indians are paying so much for their fuel. Another reason is the high rates of duties imposed on fuel imports. According to a report, the state government in India collects an average of Rs. 20 per liter of petrol while the central government collects Rs. 33 per litre. And since the government does not provide any kind of subsidies on petrol consumption, all of these taxes are reflected in prices paid by

consumers. These high levels of prices, thus beg us to ask, if the government is at fault here?

Government role in Fuel prices

Fuel is one of the few things that does not come under the ambit of GST(good and service tax). This gives both, central and state governments power over deciding how much tax they want to impose. Hence, they take advantage of this power whenever they need extra revenue. Even in times of Covid, when the economy was crippling, many state governments increased the levies imposed on fuel imports. Compared to last year, the Delhi government increased the excise duties on petrol by 66%. Such huge numbers, make it seem like it is the government’s fault that people are forced to pay unreasonable prices for their fuel needs. However, coming to such conclusions would be premature on our part.

In many big states like UP, Gujarat, the elections are due to be held within a year. Hence maintaining high fuel prices in such states hurts the government’s voter bank. Yet the fact that they are not reducing the excise duties indicates a possibility that they are forced to not change the rates.

The biggest factor at play here is Covid-19. As the country went into lockdown twice, private investments and consumption fell by huge margins, having negative impacts on the growth rates. Now, as the lockdowns have been lifted, it came onto the government to revive and stimulate the economy. Hence the government increased their expenditure in the economy by big gaps. To increase their expenditure, the government turned to their tax revenues and loans from other sources. However, their revenue base also took hits and shrunk as consumption was down and many people were unable to pay up their income taxes. 

This shows that the government’s hands are also tied. With an already shrinking revenue base, it gets difficult for them to cut rates on fuel duties. Though it is possible that state governments could be abusing their power by charging higher excise duties on fuel, yet in current times, it seems unlikely.

Future?

Moving forward, we can now ask the most important question of all, is this price surge temporary, or can Indians expect prices to simmer down in near future?

With economies around the world picking up pace and with OPEC recovering most of the losses it incurred last year, we could expect them to gradually withdraw the supply cuts. However, it doesn’t mean that oil prices will reduce.

Even if the supply of crude oil increases, the existing difference between the demand and supply for them is quite big. In addition to that, with economies becoming completely operational again, the oil demand would keep on increasing. Unless supply increases by huge margins in a short period, it is nearly impossible for supply to come close to the demand, making price diminution an unfeasible idea.

Further, even if fuel doesn’t get more expensive, still the prices of oil would likely inflate in India. That’s because of the depreciation of the Indian rupee against the US dollar. By the end of the year, a dollar would be worth Rs. 75.50, which is 3 rupees higher than a dollar value noted on June 3rd (Rs. 72.8). India purchases oil in US dollars. This means that as the value of our currency depreciates against the dollar, then we would be paying more money for the same quantity of oil we purchased in past. Hence even if prices of crude oil don’t change, yet it is possible that India would experience inflationary pressures.

The big irony here is that the effect of depreciatory pressure on the rupee is the very cause of it. As fuel prices are skyrocketing, it has taken an adverse effect on terms of trade. The demand for Indian exports has fallen. As fewer goods are demanded, the demand for Indian currency falls as well. However, with the recovering economy, the demand for imports would increase or at the very least remain the same. This results in the weakening of the Indian Rupee against the US dollar in the open market. Hence, in other words, the price surge of oil would further increase the price of oil in India, creating an upward spiral effect. Though there are other factors that also affect the rupee, yet the loop of trade India is caught in is unfortunate. 

Conclusion

These high fuel prices have troubled Indian citizens. As the economy has been recovering post lockdowns, in ideal times, fuel prices shouldn’t be so high. Fuel is a vital input cost in all industries, and with such surging prices, the cost of production has increased, which, in turn, has put inflationary pressures on all products. Further, with increased costs, the profit margins in the economy have diminished. This could demotivate firms from increasing their production, from investing their money in the market. It would prevent the recovery of growth rate, which in these times, is of great essence. 

The threat which high fuel prices pose has concerned even the RBI, as the governor has asked the government to cut down on duties imposed on fuel imports. In addition to that, opposition parties along with people are protesting for a price reduction as well. However, even amidst all such pressure, reducing fuel prices poses greater risks than incentives for the government. Even if they did, the margins won’t be enough to effectively bring down the prices.

Hence to conclude, it is safe to say that at least till the end of this year, Indians shouldn’t expect fuel prices to simmer down. There are adverse effects to this, but the economy has to live them out.

Hemang is a Second-year student at Ashoka University majoring in Economics and Finance.

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