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Introduction

The Crude Oil Prices have steadily increased over the past decade.

AGGREGATE DEMAND

Aggregate Demand

Household Consumption (C)

Government Consumption (G)

Net Exports (X)

Private Investment (I)

Aggregate Demand

Impact on Net Exports (X)


Crude Oil forms 30-32% of Indian Import Basket 80% of Oil demand is met through imports Imports have been stagnant at $38 -$40 Billion Rupee has depreciated 27% (44/$ to 56/$)

In Rupee terms Imports have increased reducing the Net Exports (X) component of aggregate demand.

Impact on Household Consumption (C)


Affects the Cost of Production Diesel Trucks and Railways, fertilizers and pesticides for agriculture, plastic-manufacturing Major Contributor to Cost Push Inflation Prices of Products are partially increased to Offset production costs

High Inflation with negative sentiments to future prices led to decrease in household consumption

Impact on Government Consumption (G)


Cushioning effect though fuel price subsidies Administered Pricing Mechanism Increases the government expenditure Partial pass-through of price rise cushions the fall in household disposable income, which has a positive impact on Aggregate Demand However this is not sustainable in the long term considering the supply side bottlenecks and the rising Fiscal Deficit In Long Term its advisable for the Government to reallocate the money used for subsidy to more productive channels, like incentivizing the search for Crude Oil sources domestically Government can also attempt Long-term capital formation through infrastructure development

Impact on Private Investment

Private Investment has reduced due negative business expectations due to Decreasing Aggregate Demand Persistently high interest rates

Overall Impact and RBIs Monetary Policy stance


Reduction in GDP growth rate -higher unemployment levels Cost-Push Inflation has hit the BOP hardest

Situation of Stagflation
RBI had hiked the Repo Rate 13 times along with CRR hikes Fight inflation by sucking the liquidity in the market

Control Demand side


Current inflation is mainly due to supply side and not a demand side inflation , thus rendering the above measures ineffective

Fuel and Food major contributors to inflation With supply side constraints, the impact of monetary policy is minimal Cost-Push policy can be countered as reducing demands will force the manufacturers to reduce the mark-up to increase the demands

Transmission of International Oil Prices to India

The three broad channels through which the international oil prices have a deep impact on the economy are a) Import Channel b) Price Channel c) Fiscal Channel Import Channel:

India is a Net Importing Country Susceptible to foreign bill variations Rise in Oil prices means real growth reduces The Compression in aggregate Demand dampens the Growth

Price Channel

Price channel is indicated by the link from international oil prices to increase in administered prices to WPI inflation The objectives for regulation of price of oil have been three-fold: To protect the domestic economy from volatility in international oil prices To provide merit goods to all households, To protect poor consumers so that they may obtain kerosene (through PDS) and LPG at affordable

If the administered price of crude oil, gas and petroleum increase by 7 per cent, The overall WPI increases by 1 per cent (i.e. the total elasticity to be 0.14) 10% increase in Global Prices 1 %point increase in WPI and 2% over time

Fiscal Channel

Absence of a complete pass-through, an international oil price increase will raise the subsidy on oil
Increase the revenue expenditure of the government

Oil prices though subsidized also generate revenue for both state and centre A rise in international oil prices affects the tax collected The Tax Collections should however rise to result into a net addition into the subsidy

Contribution of Petroleum Sector in Government Exchequer

2.8 % of the GDP Over 60% of State Exchequer 3 years Tax contribution has been higher than the subsidies provided by the government

Contribution: Rs 136,000 crore and state 80,000 crore

Subsidy including Oil Bonds Rs.40,000 Crore

International Comparison of Petroleum Prices

The table shows: Price of all products except kerosene are higher than international market

This is applicable to the subsidized diesel

The table below compares prices of petrol with other countries

Break up of Retail Prices

Taxes are close to 50% of retail price More than 50% of taxes are collected in form of Excise

Projection of Financial Burden on India

The table above shows the projected consumption by 2020-21 and 2030-31 The two assumptions made in Kirit Parekh Report (2010)
The average annual compound growth rates of petrol diesel kerosene LPG during 2002-3 to 2008-09 will apply to 2020-21 & 2030-31 The Current Level of prices set by government will continue

The under-recoveries of oil marketing companies on these Four :

At price of $80/barrel , the total under-recoveries work out to Rs.157,000 Crore by 2021
At 25% increase to $100/Barrel , under-recoveries increase by 77% At 50% increase to $120/barrel, under-recoveries increase by 155%

Higher GDP Growth Rate Higher Under-Recoveries

The Figure below represents under-recoveries of OMCs on sale of petrol diesel LPG and PDS Kerosene

These estimates reveal the share Diesel in Under-Recoveries and is Projected to Increase from 45% of Crude to 58% at $150/barrel by 2020-21

Financing the UnderRecoveries

Financing the UnderRecoveries


Significant impact on oil companies, notably the upstream national oil companies They are currently shouldering the majority of the nongovernment burden On Elimination , money would allow the companies to be properly and fairly financed One way to finance part of the under-recoveries is to levy a windfall profit tax on all upstream companies who were allotted blocks on nomination basis The Chaturvedi Committee has suggested a special oil tax on domestic producers of crude oil on pre-NELP leases 100% from a price level of $75/bbl so as to manage the huge under-recoveries estimated for 2008-09.

The tax should be either


(i) annulled (ii) re-set downwards to equal the fuel subsidies made available only to BPL families for SKO and LPG

Conclusion & Policy Implementation


International oil price shock is expected to result in lower growth and higher inflation, via the trade channel, the fiscal channel and the price channel More substantial reforms are needed, including full deregulation of diesel prices, and periodic increases of domestic liquefied petroleum gasoline (LPG) and Public Distribution System (PDS) kerosene prices Harmonize petroleum sector taxation with the proposed goods and services tax (GST) in the framework of a tax on value-added Reviewing and improving the tax system would yield a range of benefits for the Indian economy, but can be seen as a medium- to long-term measure It is possible to proceed with diesel subsidy reform without changes to the tax system

Conclusion

Reforming fuel subsidies would improve Indias fiscal balance


Create fiscal space for increased investment in physical and social infrastructure or other development-related expenditures This will remove current market distortions (such as the growing number of private vehicles being manufactured to run on diesel) Incentivize energy efficiency and clean energy solutions, thereby reducing pollution levels Removing fuel subsidies entirely would also remove opportunities for corruption and selling fuel on the black market

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