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Wednesday, November 14, 2007

High oil prices pose risk for India policy, economy

India's foot dragging over ways to limit losses at state-run oil refiners who are selling cheap fuel at a time when global crude is at giddy new highs poses a risk for public finances and the booming broader economy.

Bleeding more than $50 million a day, firms like Indian Oil Corp are in dire need of rescue but a government facing elections in a key state in December is shying away from the most obvious response -- a hike in state-administered fuel prices.

India is this year yet to raise prices of widely consumed transport and cooking fuels, kept low to protect poor consumers and help fight inflation, while crude oil has jumped to around $95 a barrel.

On Monday, Oil Minister Murli Deora said officials were attempting to minimise any rise in fuel rates when it does respond -- maybe this week -- but analysts said other approaches were not risk free.

"They might reduce the import duty. This would mean a loss of revenue and put pressure on the fiscal deficit," said D.H. Pai Panandikar, an analyst with independent think-tank RPG Foundation.

"The long-term solution is to reduce demand and increase prices. But the government is hurting itself. For them party is above the nation."

The Congress party of the prime minister, Manmohan Singh, which leads the ruling coalition, has been badly bruised in recent weeks by a row with communist allies over a nuclear energy deal with the United States that still could tip the country into early parliamentary elections.

India levies a 5 per cent import tax on crude, and taxes make up 32 percent of diesel prices and 54 percent of petrol prices.

Another possible escape route would be for the government to issue more of the bonds it routinely uses to partially offset the losses of state fuel companies.

But economists say this would end up increasing India's fiscal burden and only buy time.

"They will have to issue more oil bonds, which is nothing but pushing ahead the inevitable," said Shubhada Rao, chief economist at Yes Bank in Mumbai.

Hard times ahead

The Reserve Bank of India (RBI) has said it is imperative to pass on some of the increases in global crude prices to domestic consumers.

The Indian crude basket has risen by 145 per cent since April 2004, but retail prices of petrol have gone up by just 29 percent and those of diesel by 40 percent. India imports 70 percent of its crude requirements.

Falling US stocks as winter approaches and tensions in the Middle East could push crude beyond $100 a barrel, traders say.

China, which like India forces its state oil firms to shoulder any losses from refining costly imported crude, surprised markets with a 10 percent price rise last week.

And economists say with headline inflation at five-year lows close to 3 percent, India has room to follow suit.

"The overall impact of a likely revision on domestic fuel prices on headline inflation rate is expected around 40 basis points," said Rao.

"I think the options are ... limited considering the extent of losses of the oil marketing companies. So they may have to use a combination of measures, of which price revision is an important one."

Oil firms are lobbying to pass on higher cost to consumers.

"If the domestic prices do not increase, the under-recoveries will go up further in November. Let the consumer pay one-third of the under-recoveries," said Indian Oil Corp Chairman Sarthak Behuria.

Economists estimate that despite an improvement in the fiscal deficit over the past three years, off-budget items such as oil and food bonds, fertiliser subsidies and losses of state power firms add up to 2 percent of gross domestic product.

"The economy's unexpectedly strong growth over the last four years has complemented some fiscal reforms to improve public finances," Rajeev Malik, analyst at JP Morgan in Singapore, said in a research note.

"However, the actual improvement is overstated because of higher off-budget spending."

The Manila-based Asia Development Bank estimates that every $10 rise in average global oil prices shaves off 1.1 percentage points from India's economic growth.

"If oil prices remain high it will definitely hurt growth. If they remain at current levels it would impact industrial production by as much as one percent," said Panandikar.

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