Oiling the economy

Price of black gold or crude oil is very crucial for India's macro-stability.

Being heavily reliant on imports to meet the domestic requirement of crude oil and liquefied natural gas (LNG), any swing in their prices directly impacts the current account deficit (CAD), inflation, fiscal deficit and subsidies. Any change in these macro-economic numbers also affects the government's ability to spend, fund the Budget and garner tax revenues.

Therefore, it would not be wrong to conclude that a major factor that helped the Prime Minister Narendra Modi-led National Democratic Alliance (NDA) government deliver on the macro front was benign crude prices.

End of the heat wave

From a high of $111.89 per barrel in the financial year (FY) 2011-12 during the United Progressive Alliance (UPA) regime, the average price of crude fell to $84.16 a barrel in 2014-15 – the first fiscal year of the Modi government. From there, the average crude price fell to $47.17 per barrel in 2015-16 and remained around the level of $47.56 in 2016-17. Next fiscal, crude prices started climbing up and averaged $56.43 per barrel. And for the most part of the ongoing financial year, oil prices have remained elevated at over $60 a barrel.

Softening crude prices helped the government in narrowing the CAD, or the shortfall in the value of exports as compared to imports. From 5.02% of the gross domestic product (GDP) in 2011-12 when prices had jumped to over $100 per barrel, CAD was brought down to 1.1% in 2014-15. The chasm between imports and exports was further closed to just 0.55% of GDP in 2015-16. The next two fiscals – 2016-17 and 2017-18 – saw CAD at 1.55% of GDP and 2.43% of GDP, respectively.

A similar story played out for average retail inflation and fiscal deficit, too. The Modi government has been able to douse the inflation rate from a scorching 10.1% in 2011-12 to 4.9% in 2014-15 and tamed it further to 3.6% in 2016-17. Lately, the inflation is inching up again with a firmer crude.

And as crude prices eased, the government was also able to narrow the fiscal deficit by keeping the retail prices of petrol and diesel at higher levels. Tax revenue collection from fuel swelled due to the the increase in petrol prices. This happened as the ad-valorem tax component also shot up in the revenue collection.

Filling the reservoir

By doing so, the government's collection from excise duty on petroleum products soared. This brought the fiscal deficit under control and also funded several of the government's infrastructure projects and social programmes.

Ranen Banerjee, leader - public finance and economics, PwC India, said revenues generated from excise on fuel became a significant part of government's total revenue and an important tool for financing Budget programmes.

As per his estimate, it currently stands at around 18-20% of the national income.

"If you look at the pump prices during the period crude prices had slumped, they were fluctuating but were not fully reflecting the fluctuations in the global crude prices. That led to additional revenues in terms of additional taxes when oil prices were low. Given the revenues from oil for the government were significant, it helped in Budget financing and was a financing tool for not only the Centre but for also the states," he said.

Banerjee said lower crude prices pinned down the subsidy spend, too.

Madan Sabnavis, chief economist, CARE Ratings, believes not more than 10% of the gains from low crude prices have been passed on to the consumers.

The big swap

Instead of transferring the savings from lower crude prices, the government has used them for social schemes, redistributions and capital expenditure.

Sabnavis feels the current government was able to meet macro targets on CAD, inflation and fiscal deficit in the last five years largely because of the softer crude prices.

"To a large extent, CAD, inflation, interest rates and fiscal numbers have been protected on account of crude oil prices. They have been able to take advantage of it because whatever money was saved on the fiscal side there is evidence to show that the government has been proactive in spending it on not just on infrastructure but also on social programmes," said the CARE economist.

He said a large part of what was spent on capital expenditure was the money freed up from fuel subsidies, which were redirected to other spends.

Between 2013-14 and 2015-16, central government revenues through levies on petrol and diesel more than doubled to Rs 1.79 lakh crore from Rs 77,982 crore. As per the government data, excise duty on unbranded petrol increased to Rs 21.48 per litre in 2017 from Rs 9.48 per litre in April 2014. For diesel, it rose to Rs 17.33 per litre from Rs 3.56 per litre during the same period.

Figures shared by the government in the parliament reveal the Centre's gross revenue collections from petroleum products – petroleum, oil and lubricant (POL) – rose steadily between 2014-15 and 2018-19 from Rs 1.05 lakh crore to an estimated Rs 2.57 lakh crore in 2018-19.

Statistics from Petroleum Planning & Analysis Cell (PPAC) show contribution of the petroleum sector to the exchequer consistently rose from Rs 1.26 lakh crore in 2014-15 to Rs 2.09 lakh crore in 2015-16, to Rs 2.73 lakh crore in 2016-17 and Rs 2.85 lakh crore in 2017-18. For the nine months of 2018-19, it was Rs 2.08 lakh crore.

The juggling act

This rise in tax revenues from fuel came at a time when the global crude prices had moved South and touched record lows.

After severe criticism for not passing the benefits of low prices to consumers, the government replaced the additional excise duty of Rs 6 a litre on petrol and diesel with a road and infrastructure cess of Rs 8 per litre on the fuels. It further cut basic excise on the petroleum products by Rs 2 a litre. This reshuffle was seen as financial engineering as the government continued to earn good revenues from taxes on petrol and diesel.

Revenues generated from excise duty on fuel were a source of funds for the government to keep the fiscal deficit within the targeted level of 3-3.5% of GDP and enhance productive capital expenditure.

Perfect equations

As a rule of thumb, every $5 per barrel increase in crude price pushes up import bill by $10 billion and vice-versa, provided the currency remained stagnant.

A paper on impact of crude price on India's CAD, inflation and fiscal deficit brought out by Reserve Bank of India's (RBI) Saurabh Ghosh and Shekhar Tomar estimates trade deficit at $68.9 billion or 2.33% of GDP when crude price is $55 per barrel. At $65 per barrel, the RBI economists see CAD at $81.4 billion or 2.76% of GDP.

If their estimates hold, then CAD, after dropping to as low as 0.55% of GDP, could well be headed to over 3% of GDP or more than $90 billion as crude prices move above $70 per barrel. If crude prices were to scale up to around $85 per barrel, the RBI duo forecast trade deficit to creep up to 3.6% of GDP or $106.4 billion.

In the December quarter of 2018-19, CAD was at 2.5% of GDP, narrower than 2.9% in the preceding quarter.

Interestingly, the RBI executives found that crude price shocks on the Indian economy were irrespective of higher growth of GDP. They calculated that a $10 per barrel rise in global oil price can sear domestic inflation by roughly 49 basis points (bps) or widen fiscal deficit by 43 bps of GDP if the government were to absorb the entire higher cost and not shift it to consumers. One basis point is a hundredth of a percentage point.

According to Ghosh and Tomar, wider CAD on account of crude price rise also remains largely immune to healthier GDP growth. "To test this (relief to CAD due to higher GDP growth), we look at changes in CAD/GDP ratio with respect to nominal GDP growth and find that a 100 bps increase in GDP growth rate can only shave off 2 bps in CAD/GDP ratio".

Back to the future

And as crude prices flare up again on supply shortage due to US sanctions on Iran and Venezuela and other geopolitical factors, the government has pressed the panic button.

There are projections of crude scaling up to $100 per barrel. And if that happens, domestic macros will move into a dangerous zone and wipe out all the gains accrued due to benign crude prices during a major period of NDA regime since 2014-15.