PremiumOil above $100 could outlast today’s crisis. We should up fuel prices, snip levies, support the rupee for now and tighten money to fend off inflation. Growth, alas, is likely to suffer anyway
Economic relief from the Ukraine crisis would merely be a matter of degree. A realistic look at the market for crude oil amid Cold War II tensions would suggest that the latest global price flare-up will not blow over anytime soon. Indeed, it could last longer than we can afford to wait before taking action. The mere hint of a possible US-led clamp on Russia’s vast exports saw oil spike on Monday to levels unseen since the shock of mid-2008, before the EU balked and the US placed its own little import ban on Russian oil and gas, rather than go for drastic sanctions. Standby oil is too short; even an unlikely mix of diplomacy and supply spurts may fail to stop global output from lagging demand, a projected scarcity that had put oil on an uptrend for weeks earlier. Meanwhile, Moscow could impose its own squeeze, as it has threatened with gas for Europe, in fierce retaliation to its isolation by the West. In any case, as Russian crude is seen as too hot to handle, its overseas availability has sputtered. If oil futures are seeing bets of $200 per barrel, about $60 higher than Monday’s peak, blame it on a probability matrix loaded against an easy way out. In other words, an oil shock is upon us, prices may stay above $100 for months on end, and we must minimize the attendant risks to India’s economy.
With net imports estimated to reach around 1.5 billion barrels in 2022-23, India stares at a hugely inflated oil bill. As our Union budget for next year had assumed far cheaper energy, its math would need to be redone. For now, a hike in retail fuel prices is unavoidable, but we also need to relieve inflationary pressures, so price revisions ought to be modest. The government should slash fuel levies and absorb much of the blow. Taxes had been raised after oil softened in 2014, but this source of revenue has run its course. The enlarged fiscal gap will have to be plugged through other means—or simply borne to stem the ripple effects of pricey fuel on other retail prices. A weaker rupee is also a burden. As the oil shock pushes up domestic demand for dollars to pay swollen import bills, while foreign investors liquidate local assets for US greenbacks, our currency has fallen to almost ₹77 per dollar. An energy-widened trade gap is likely to weigh it down further. Lest sharper drops spur bigger outflows of hot money, exchange-rate volatility needs to be contained by our central bank using its dollar reserves to buy rupees, as it has been doing. By way of short-term policy, it would make sense at this juncture to support the rupee till some stability is attained, before we let it float freely again. Buying cash slurps up local liquidity, of course, which can exert upward pressure on the cost of credit across the economy. But then, this is favourable because it also helps fend off price instability.
As for monetary policy, extra cost burdens look set to drag economic growth down in a way that cheap lending may be unable to arrest anyhow, given weak private demand overall and the visibly low efficacy of supply-side covid measures like easy money, while retail inflation could plausibly still be kept capped at 6% if credit begins to tighten. In its April policy review, our central bank should stiffen its stance and go after inflation, an outbreak of which will be hard to quell later on. This risk outweighs the uncertain gains of a negative real rate of interest, which is untenable for a prolonged period anyway. Under uncertainty of today’s sort, safety should be our priority.
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