Scraping the barrel on oil

| Updated on January 21, 2012

There has to be some rationalisation of consumption, which cannot happen if prices are not allowed to adjust even reasonably for forces of supply and demand to balance each other.

There is arguably no bigger immediate problem facing the Indian economy than oil. Since August, the rupee has fallen from an average of Rs 45.3-to-the-dollar to the current Rs 52-53 levels. This, even as the same period has seen the average price of crude paid by Indian refiners only going up from below $ 107 to above $ 110 per barrel, translating into an effective rupee increase of 20 per cent or so. Moreover, unlike in 2008 – when global crude prices plunged from their $ 133/barrel average highs in July to below $ 42 by December – the recurrence of a worldwide economic slowdown this time has not provided any respite on the oil front. Starting from the NATO military intervention in Libya in March to the latest threat of an Iranian blockade of the Strait of Hormuz that might affect shipments from the Persian Gulf, there has been some factor or the other holding up prices. Encouraging jobs data boosting hopes of the US economy staging a recovery have even further emboldened hedge funds to increase their bullish bets on oil.

For India, matters have been additionally complicated by payment problems vis-à-vis Iran, which supplied 18.5 million tonnes (mt) out of the country's total crude imports of nearly 164 mt in 2010-11, next only to Saudi Arabia's 27.4 mt. The recent US move imposing sanctions on financial institutions that deal with Iran's central bank have made it difficult for Indian oil firms to route payments even through third-party banking channels such as Turkey. In the event of these windows closing – Turkey has already indicated to this effect, while a deal with Russia is still to be worked out – it would take some effort to find alternative suppliers. All these would add up to a staggering oil import bill - $ 150.5 billion in 2010-11 and 43 per cent higher, at over $ 94 billion, during April-November – that would continue to put pressure on the rupee and the official foreign exchange reserves.

What are the options before the Government now? Not too many, really. Upcoming elections to crucial State assemblies rule out any possibility of the increased oil import costs being passed on to consumers here till end-February. But this cannot obviously go on. There has to be some rationalisation of consumption, which cannot happen if prices are not allowed to adjust even reasonably to balance supply and demand. The Union Budget, to be presented once the current polls end, provides just the right platform to take tough decisions on diesel and LPG price decontrol. To start with, there can be small and frequent doses of price hikes, in order to minimise any cascading effect on the rest of the economy. These could be the precursor to eventual full decontrol within a prescribed time schedule.

Published on January 11, 2012

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