Rising Crude Oil Prices Force Indian Government to Resort to Steep Hike in Retail Fuel

Summary

Rising crude oil prices force Indian government to resort to steep hike in retail fuel prices and cut duties …

This leads to a spiralling inflation, which as on 13 June was at a 13 year high of 11.42 percent

Runaway inflation forces the Reserve Bank of India to further tighten the monetary policy. Cash Reserve Ratio (CRR) and Repo Rate hiked. This would make borrowing costlier and put to hold investment decisions of many companies.

All the above issues might spook the Indian growth story. Government sources as well as international agencies have pegged India’s economic growth at 8 percent or less for 2008-09.

Industrial production in April, the first month of fiscal 2008-09, grew 7 per cent, much lower than the 11.3 per cent growth in the same month last year, but nearly double the revised IIP growth of 3.9 per cent in March.

However growth of India’s six core industries slowed down to 3.6 per cent in the first month of the current fiscal as against 5.9 per cent a year ago.

FDI inflows continue unabated especially in energy, services, construction and real estate sectors.

Indian exports grow 22.9 per cent in 2007-08, marginally higher than a 22.6 per cent growth registered in the previous fiscal

Will trade reforms lead to an end of the global food crisis or would it exacerbate the current situation. This seems to be the dilemma of the Doha round as brought out by a World Bank report

Indian business chambers express concern over concerted attempts to undermine the “development dimension” in Doha even as the Indian Trade Minister points out that the 21 July WTO round is the last window to close the negotiations.

Detail

Fuel Price Hike

1. Even as the crude oil prices are touching new highs, the Indian government on 5 June finally bit the bullet and announced a steep hike in the prices of petrol (up by Rs 5), diesel (up by Rs 3) and LPG - cooking gas (up by Rs 50). Fuel prices were earlier hiked in February 08 – when oil prices hovered around $100 a barrel – and this was after a gap of twenty months. Along with these hikes the government also cut into its revenue by reducing the customs duty on crude oil from 5 per cent to nil, and on petrol and diesel from 7.5 per cent to 2.5 per cent. The customs duty on jet fuel and other petroleum products has been reduced to 5 percent from 10 per cent. All these measures were taken to ease the subsidy burden on the oil-marketing companies that were being badly bruised by the rising crude prices.

Inflation

1. The hike in fuel prices got reflected in the inflation figures as it surged from 8.74 (in May) to 11.05 percent (1st week of June) and was 11.42 percent for the week ending 13 June 08. The government was bracing itself for high inflation driven by the 17% fuel price rise. But what is worrying is the increase in food products that saw a 24% rise, and manufactured goods- a 17.2% rise, that were also major drivers of inflation in that particular week.

Measures to rein inflation

1. The Reserve Bank of India (RBI) that had set an inflation target of 5.5 percent tightened the monetary policy further to rein in the runaway inflation. On 20 June 08 it raised the repo rate (the rate at which banks borrow money from the RBI) and the cash reserve ratio - CRR (the proportion of the deposits banks have to keep with the RBI) by 50 basis points each. RBI had earlier raised the repo rate by 25 basis points on 11 June 08 and the CRR in April 08. Analysts are expecting the RBI to further tighten its policy, as inflation shows no signs of abatement.

1. On the fiscal front government had earlier cut duties on a number of products and banned trading in futures contracts for key staple foods and export of certain commodities is yet to decide on further measures. The measures however are yet to show any results. The combined lagged effect of the monetary policy and fiscal measures might help rein in inflation in months to come.

Result - Lower GDP forecasts

1. The tight monetary policy has made borrowing costlier for both industry and consumers. This is likely to affect both production and consumption. Industrial units that were keen on adding to capacities have put their investments on hold. The high inflation, led by food prices has forced consumers to put on hold their buying decisions for luxury items.

1. GDP growth for 2008-09 is likely to be dampened. Most agencies – international and private as well as Government have scaled down their growth forecast for this fiscal.

1. Prime Minister Economic Advisory Council scaled down its projection for economic growth this fiscal from 8.5% to 8% owing to domestic and international factors like rise in crude oil and commodity prices. The Council Chairman C Rangarajan said “Given the domestic and international factors, it may be reasonable to expect the growth rate to remain around 8% in 2008-09."

1. The World Bank indicating a slowdown in the Indian economy projected an economic growth of 7% for India in 2008 due to tightening of monetary policy to rein in inflation that would result in a decline in demand for industrial goods. “GDP growth in India eased to a still strong 8.7% in 2007, from 9.7% in 2006, and is projected to slow further to 7% in 2008,” the World Bank report said. The bank’s projections are very much in line with the pronouncements made by both investment bank Goldman Sachs and the International Monetary Fund (IMF) which said that India’s GDP growth was expected to slow to 7.8% in 2008-09. “What one can see clearly is that manufacturing is slowing in a gradual manner, confirming what we have seen in the index of industrial production figures,” Joshua Felman, IMF’s senior resident representative in India had said. Agencies like Standard and Poor (S&P) have also lowered their growth forecast for the current year to 7.8% from 8.6% earlier as it felt that the economy would be hit by the surge in inflation fuelled by energy and commodity prices.

1. Business chambers like CII (Confederation of Indian Industries) however had a positive view of the economy. In a report it says “India could record a GDP growth of about 8.6% during 2008-09, with increasing capital expenditure by the private sector and healthy incremental capital output ratio at around 4.”

Industrial production marginally up

10. Industrial production in first month of Q1 grew 7 per cent, much lower than the 11.3 per cent growth in the same month last year, but nearly double the revised IIP growth of 3.9 per cent in March 08. The rebound is better considering that consumer durable production had actually declined 1.7 per cent in March this year, heightening worries that interest rates were crimping consumer spending. The April growth in the Index of Industrial Production (IIP) was led by an improved performance of the capital goods and consumer durables sectors. Most economists are expecting IIP growth to slow in the current fiscal year as a whole.

Source: Central Statistical Organisation

However growth in Core Industries lag

1. Growth of India’s six core industries (that have a 26.68 percent weight in IIP) slowed down to 3.6 per cent in the first month of the current fiscal as against 5.9 per cent a year ago. The six-core infrastructure industries including crude oil, petroleum refinery products, coal, electricity, cement and finished carbon steel-had registered a 9.6 per cent growth in the preceding month of March.

Performance of Six Infrastructure Industries

Source: Concerned Ministries/ Departments/Organisation(s)

FDI Inflows

1. Energy, services, construction and real estate sector’s received massive inflow of FDI to the tune of USD 20.8 billion in the last four years viz. 2004-05 to 2007-08. Overall FDI increased from USD 2.2 billion in 2003-04 to USD 25 billion in 2007-08. FDI share in India's GDP has increased from 0.77 per cent in 2003-04 to 2.31 per cent in 2007-08. The government has set a target of USD 35 billion for 2008-09. The global economic slowdown and spiralling inflation caused by increasing crude prices however might adversely impact realisation of the FDI target.

Exports

1. Indian exports driven by a huge jump in engineering goods, gems and jewellery and petroleum products grew 22.9 per cent in 2007-08. The three mentioned sectors contributed 68 percent to the export growth. Exports stood at USD 155.4 billion in 2007-08, against USD 126.4 billion in the previous fiscal.

1. Sources at RBI indicated that said the growth in exports, during FY'08, was close to the average export growth of 23.5 per cent recorded during the previous five years, indicating a strong upward momentum. Indian imports, during the period, registered a higher growth at 26.9 per cent as against 24.5 per cent a year ago, on the back of higher growth in both oil and non-oil imports. Total imports in FY 08 stood at USD 235.7 billion, against the last fiscal USD 185.7 billion imports.

The Doha dilemma – Global food crisis versus trade reforms

1. The global food crisis has shone a harsh spotlight on the consequences of government meddling in agriculture. Poor people go hungry, in part, because rich countries pay their farmers to divert crops from food to fuel. But in at least two areas, the crisis has emboldened those who are skeptical of free markets in food. The first is “food security” and the second ‘‘concern for poor’’. Politicians in rich and poor countries have seized on recent price spikes as proof that free farm trade is a risky business and self-sufficiency a worthy goal. For years reformers have advocated freer trade on the grounds that market distortions, particularly the rich world’s subsidies, depress prices and hurt rural areas in poor countries, where three-quarters of the world’s indigent live. The Doha round of trade talks is dubbed the “development round” in large part because of its focus on farms. But now high food prices are being blamed for hurting the poor (the topic of UN summit in Rome last month).

1. The notion that free trade precludes food security is plainly wrong-headed. Anyone who believes autarky is the route to food security should look at starving North Korea. In world markets trade barriers, not the lack of them, have exacerbated the mess. The commodities that have seen the biggest price spikes are those which tend to be traded least. Only 6% of global rice production, for instance, flows across borders. Unilateral export restrictions, such as those imposed by Vietnam and India, have made matters worse. Global supply is disrupted and domestic farmers discouraged from producing more. The route to deeper, less volatile markets lies through freer trade and fewer distortions. The links between trade, food prices and poverty reductions are more subtle.

1. Different types of reform have diverse effects on prices. When countries cut their tariffs on farm goods, their consumers pay lower prices. In contrast, when farm subsidies are slashed, world food prices rise. The lavishness of farm subsidies means the net effect of fully freeing trade would be to raise prices, by an average of 5.5% for primary farm products and 1.3% for processed goods, according to the World Bank report.

1. But things are not so simple. The authors of the report point out that net food buyers tend to be richer than net sellers, so high food prices, on average, transfer income from richer to poorer households.

1. And prices are not the only route through which poverty is affected. Higher farm income boosts demand for rural labour, increasing wages for landless peasants and others who buy rather than grow their food. Several studies show this income effect can outweigh the initial price effect. Finally, the farm sector itself can grow. Decades of under investment in agriculture have left many poor countries reliant on imports: over time that can change.

1. The World Bank has often argued that the balance of all these factors is likely to be positive. Although freer farm trade—and higher prices—may raise poverty rates in some countries, it will reduce them in more. However lately the bank seems to be taking a different line. Robert Zoellick, the bank’s president, claims that the food-price crisis will throw 100m people below the poverty line, undoing seven years of progress.

1. These subtleties suggest two conclusions. First, the bank and others should not make sweeping generalisations about the impact of food prices on the poor. Second the nature of trade reform matters. Removing rich-country subsidies on staple goods, the focus of debate in the Doha round, may be less useful in the fight against poverty than cutting tariffs would be. The food-price crisis has not hurt the case for freer farm trade. But it has shown how important it is to get it right.

Indian Business Chambers and Doha negotiations

1. In separate letters, Indian industry bodies FICCI and CII told WTO Chief Pascal Lamy that they are deeply concerned over concerted attempts to undermine the “development dimension” in Doha non-agricultural market access (NAMA) negotiations.

1. Both FICCI and CII listed glaring inconsistencies between what the Doha mandate required members to accomplish and what was proposed in the revised text issued last month. It mentioned that the anti-concentration clause would do enormous damage to small and medium enterprises in developing countries, they complained.

1. Despite several major unresolved issues, the WTO will be holding it crucial ministerial meeting on 21 July in their to successfully conclude the seven-year-old Doha Round talks as soon as possible. The Indian Commerce Minster Kamal Nath commenting on the meet said “This is the last window, perhaps to close this Round. (However) There is lot of work to be done before that.” The Minister also expressed hope that the members will be able to “arrive at some convergence”.

D J Rao/Rajesh Sehgal/Akansha Bhushan

Economic Section

New Delhi