Economic detox: ‘Neelkanth’ (c. 1936), Nandalal Bose
On Sunday, Narendra Modi urged the country to reduce fuel usage by opting for more public transport and WFH, lower fertiliser use, and avoid non-essential gold purchases and forex spend. For India, which imports nearly 90% of its oil needs, and whose strategic petroleum reserves are slender relative to other major economies, it's a stress test of the first order.
GoI's chief response has been to deploy fiscal resources to shield consumers from worst of the price surge. The playbook is familiar: excise duty cuts, compression of oil marketing company margins, and subsidies embedded in the pricing framework. Domestic petrol and diesel prices have remained broadly unchanged since January. In April, retail petrol prices, which had been higher than in the US at the start of the year, slipped below, a striking illustration of how far domestic prices have drifted from underlying costs.
India's response is underpinned by sound economic logic. When retail prices of petrol, diesel, LPG and kerosene spike, consequences can ripple swiftly through the economy. The poor tend to be hardest hit, since energy comprises a larger share of their household budgets. So, absorbing some of the shock is justifiable. But how much, and for how long, are crucial questions.
This is where fiscal arithmetic deserves close attention. Assume that a 50% increase in crude oil prices translates into a 25% increase in the supply cost of petrol and diesel, given limited short-term adjustment in refining and distribution margins. Applying this to projected 2026 consumption yields a fiscal cost of about 0.6% of GDP on an annual basis.
That expenditure is broadly comparable to the entire central budget allocation for agriculture, and exceeds government spending on public health. The calculation is also probably an underestimate, since it doesn't adjust for rupee's depreciation against dollar. At a time when fiscal consolidation remains a priority and public debt is declining only gradually, this is a substantial call on scarce budgetary resources.
There is also a targeting problem that complicates the equity argument for price suppression. Not all fuels have the same income-consumption profile. In fact, more than 80% of Indian households don't purchase petrol or diesel directly. Primary beneficiaries of cheap petrol are private vehicle-owners, a constituency concentrated in the upper income deciles. Protecting the vulnerable is right. But blanket price suppression is a blunt instrument for achieving it.
Applying the same back-of-the-envelope calculations to a cross-country sample suggests that India is somewhere in middle of the pack of Asian oil importers. Its fiscal exposure from maintaining unchanged prices is lower than in Indonesia, Malaysia and Thailand. But it's higher than in advanced Asian less-fuel-intensive economies like Japan and South Korea. Meanwhile Sri Lanka, the Philippines and Vietnam have already adjusted domestic prices in response to rising costs, suggesting that price adjustment, managed carefully, is achievable even in economies with a significant share of low-income households.
Perhaps an even deeper concern is structural. India's strategic petroleum reserves - a buffer against exactly the kind of supply shock now unfolding - are a fraction of those maintained by other major economies. They amount to less than 2% of China's reserves, about 5% of the US', and 27% of South Korea's. With domestic crude production having fallen by around 26% over the past decade, and import dependence now approaching 89% of total oil needs, combination of thin reserves and high dependence leaves India acutely exposed to geopolitical flashpoints. Addressing this vulnerability is a long-term project that needs to begin in earnest.
None of this is to advocate for an immediate fiscal-tightening, or sharp increase in retail prices. That would be economically disruptive and socially regressive. Instead, a gradual, well-signalled restoration of price pass-through, accompanied by targeted support for households that genuinely need protection, is needed.
Apart from restoring fiscal prudence, this would also help maintain a level playing field between state-owned oil marketing companies and private retailers, without which the sector is unlikely to attract the kind of investor interest it needs to thrive in the long run.
GoI should also address structural issues the crisis has thrown into sharp relief. Strategic petroleum reserves need to be built up to levels commensurate with India's import dependence. RE transition should be accelerated. The petroleum intensity of the economy has barely shifted over the past 5 yrs. And the tax framework needs to be put on a sounder footing. Contribution of petroleum taxes to central government revenues has declined sharply over the last 5 yrs, partly due to the failure to adjust excise duties for inflation.
India has navigated oil shocks before, and will navigate this one. The short-term instinct to cushion the blow for ordinary citizens is understandable. The challenge now is to ensure that this instinct is translated into well-targeted support, rather than broad price suppression, especially if crude oil prices remain elevated for an extended period. Structural reforms needed to reduce India's exposure to future shocks should begin now, not be deferred to the next crisis.
GoI's chief response has been to deploy fiscal resources to shield consumers from worst of the price surge. The playbook is familiar: excise duty cuts, compression of oil marketing company margins, and subsidies embedded in the pricing framework. Domestic petrol and diesel prices have remained broadly unchanged since January. In April, retail petrol prices, which had been higher than in the US at the start of the year, slipped below, a striking illustration of how far domestic prices have drifted from underlying costs.
India's response is underpinned by sound economic logic. When retail prices of petrol, diesel, LPG and kerosene spike, consequences can ripple swiftly through the economy. The poor tend to be hardest hit, since energy comprises a larger share of their household budgets. So, absorbing some of the shock is justifiable. But how much, and for how long, are crucial questions.
This is where fiscal arithmetic deserves close attention. Assume that a 50% increase in crude oil prices translates into a 25% increase in the supply cost of petrol and diesel, given limited short-term adjustment in refining and distribution margins. Applying this to projected 2026 consumption yields a fiscal cost of about 0.6% of GDP on an annual basis.
That expenditure is broadly comparable to the entire central budget allocation for agriculture, and exceeds government spending on public health. The calculation is also probably an underestimate, since it doesn't adjust for rupee's depreciation against dollar. At a time when fiscal consolidation remains a priority and public debt is declining only gradually, this is a substantial call on scarce budgetary resources.
There is also a targeting problem that complicates the equity argument for price suppression. Not all fuels have the same income-consumption profile. In fact, more than 80% of Indian households don't purchase petrol or diesel directly. Primary beneficiaries of cheap petrol are private vehicle-owners, a constituency concentrated in the upper income deciles. Protecting the vulnerable is right. But blanket price suppression is a blunt instrument for achieving it.
Applying the same back-of-the-envelope calculations to a cross-country sample suggests that India is somewhere in middle of the pack of Asian oil importers. Its fiscal exposure from maintaining unchanged prices is lower than in Indonesia, Malaysia and Thailand. But it's higher than in advanced Asian less-fuel-intensive economies like Japan and South Korea. Meanwhile Sri Lanka, the Philippines and Vietnam have already adjusted domestic prices in response to rising costs, suggesting that price adjustment, managed carefully, is achievable even in economies with a significant share of low-income households.
Perhaps an even deeper concern is structural. India's strategic petroleum reserves - a buffer against exactly the kind of supply shock now unfolding - are a fraction of those maintained by other major economies. They amount to less than 2% of China's reserves, about 5% of the US', and 27% of South Korea's. With domestic crude production having fallen by around 26% over the past decade, and import dependence now approaching 89% of total oil needs, combination of thin reserves and high dependence leaves India acutely exposed to geopolitical flashpoints. Addressing this vulnerability is a long-term project that needs to begin in earnest.
None of this is to advocate for an immediate fiscal-tightening, or sharp increase in retail prices. That would be economically disruptive and socially regressive. Instead, a gradual, well-signalled restoration of price pass-through, accompanied by targeted support for households that genuinely need protection, is needed.
Apart from restoring fiscal prudence, this would also help maintain a level playing field between state-owned oil marketing companies and private retailers, without which the sector is unlikely to attract the kind of investor interest it needs to thrive in the long run.
GoI should also address structural issues the crisis has thrown into sharp relief. Strategic petroleum reserves need to be built up to levels commensurate with India's import dependence. RE transition should be accelerated. The petroleum intensity of the economy has barely shifted over the past 5 yrs. And the tax framework needs to be put on a sounder footing. Contribution of petroleum taxes to central government revenues has declined sharply over the last 5 yrs, partly due to the failure to adjust excise duties for inflation.
India has navigated oil shocks before, and will navigate this one. The short-term instinct to cushion the blow for ordinary citizens is understandable. The challenge now is to ensure that this instinct is translated into well-targeted support, rather than broad price suppression, especially if crude oil prices remain elevated for an extended period. Structural reforms needed to reduce India's exposure to future shocks should begin now, not be deferred to the next crisis.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
Shekhar Aiyar
He is director, ICRIER
Sanjeev Gupta
He is senior visiting professor, ICRIER