Retail inflation has got new prominent threat – rise in fuel prices. With further flare up in tension after Iran fired missiles on Israel, the apprehension is that if situation further aggravate and sustain for some time, then crude prices may rise and that will have impact on India.

Although crude oil prices slipped by about 1 per cent on Monday, with the market downplaying the risk of broader regional conflagration after Iran’s weekend attack on Israel, but possibility of further escalation cannot be ruled out. Brent crude is little below $90 mark.

India imports around 85 per cent of crude requirement. However, domestic prices of petrol and diesel are determined on the basis of import parity mechanism. This means domestic prices will depend on the international price of petrol and diesel and what will be cost if they are imported here. Still global crude prices are critical as product prices are derived from that. Rise in crude prices will impact product prices, albeit with a time lag.

Indirect impact

Data suggest one percentage point increase in domestic prices of fuel (petrol, diesel, LPG, etc) could add 4 basis points (100 basis points mean 1 percentage point) in the Consumer Price Index (CPI)-based retail inflation. Apart from this direct one, there could be multiple indirect impact as rise in diesel or natural gas price will also add to the freight cost or overall cost which will then be added to the primary product or finished product prices.

“Such a situation will be there, if rise in cost is passed on to the consumer. In case, public sector oil marketing companies do not pass the cost to the consumer, then their balance sheet will be impacted which in turn affect dividend paying capacity and accordingly government will be affected,” Devendra Kumar Pant, Chief Economist with India Rating & Research (Ind-Ra) said.

Geopolitical tensions

According to Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank, if the geopolitical tensions were to escalate further, there is a risk of crude oil prices surging beyond $100 per barrel. This would put upside pressure on our inflation and oil imports,” she said.

Harsimran Sahni, EVP - Head Treasury, Anand Rathi Global Finance, said that there can be threat to inflation equation due to rising commodities prices including crude oil. “Current, government might pass on the increase in crude oil to retailers post elections results. If this turn out to be the case, inflation can be slightly higher from what RBI projected,” he said.

Rise in crude prices will have mixed impact on oil companies in India. Swarnendu Bhushan, Co - Head of Research at Prabhudas Lilladher, said that Iran produces 3.2mnbopd of crude oil and also has a significant control on Strait of Hormuz which accounts for 30 per cent of oil transit and 70 per cent of oil shipment to Asia.

“Any escalation that may impact the oil production of Iran or affect the oil transit through the Strait can result in a sharp spike in the oil prices. This would affect oil marketing companies negatively as they may not be able to take commensurate price hikes. For upstream companies, realisation is managed through windfall taxes which may rise commensurately, and hence have no impact on upstream companies,” he said.