March 20, 2022

Soaring Oil Price and Imminent Stagflation

Sanjay Roy

ECONOMIC indicators once again are flashing worrying signals. The unemployment rate in India at the moment is above 8 per cent, the consumer price index (combined) taken as a measure of headline inflation is above 6 per cent and the wholesale price index showing year-on-year growth is close to 13 per cent as of January 2022. On top of that as against the first advance estimates predicting a GDP growth for the whole financial year 2021-22 to be 9.2 per cent is revised downwards in the second advance estimate to 8.9 per cent and also it is highly unlikely that the estimated growth of GDP in the last quarter (21-22) of 4.8 per cent will be realised due to Omicron and the Ukraine Russia War.
 In other words, slow growth, high inflation together with high unemployment characterise the current conjuncture and this is going to adversely impact the real income of the working people. The headline inflation or the CPI-Combined shot up in December 2019 and the high consumer price inflation continued for about a year ending in November 2020. The average inflation was 6.8 per cent during this whole period and then it came down below 6 per cent. It is once again in January 2022 the CPI-C crosses 6 per cent. The rise of consumer prices was mostly driven by food inflation which moderated by the end of 2020 and once again shows a rise in the last quarter of 2021. It is generally being held by government officials that this will ease out in the coming financial year owing to higher food production. But what seems to be even more significant is that core inflation which excludes food and energy prices shows more volatility, also, continues to be high and even higher than the combined inflation. Prices related to transport and communication, household goods and services and health show persistent high inflation.


The wholesale price index that measures prices close to production sites shot up in April 2021 crossing 10 per cent and then continued to be high as of now. The average WPI during this whole period was 12.6 per cent and in January 2022 it is 12.96 per cent. Rising wholesale prices is primarily due to existing bottlenecks in the supply chain and also because of high world commodity prices reflected partly in high minerals WPI, particularly of iron ore, lead concentrate, manganese etc. Since the weight of food components in the construction of WPI is much lower than the weight of food components in the consumer price index, during periods of food inflation CPI-C has been higher than WPI and when commodity prices increased in the world market WPI shot up while CPI-C remained more stable. But the persisting gap between CPI and WPI in the recent phase also indicates that due to low capacity utilisation and continuing low demand producers are not able to pass on the rising production costs to consumers easily.
The big companies particularly those that have large reserves can sustain themselves by absorbing the rising production costs. But the medium and small enterprises are increasingly becoming unviable as they do not possess enough reserve to absorb the shock of rising input prices. Hence those big corporates who possess monopoly power in the product market could actually drive their sales value to record levels because of rising prices which they can pass on to consumers. This has been the case for crude oil and natural gas companies whose combined sales value in December 2021 increased by 68.2 per cent compared to the previous year, although the real volume of sales actually shrunk by 1.2 per cent. This has been the case also for petroleum refining companies and the construction sector but not in the case of consumer goods where the growth of sales value has been much lower and nominal and real values are close to each other.
The automobile sector sales grew only by 2.4 per cent in December 2021 compared to last year and in terms of nominal value, the growth has been 5.6 per cent. In other words, companies that cater to sectors where demand is relatively price inelastic; meaning consumption of those goods cannot be easily reduced due to price rise could make huge gains in net sales value during this period by taking advantage of the price rise.
It is evident that the current inflation is essentially driven by rising costs and accompanied by unemployment and slow growth. And the immediate fear is Ukraine-Russia war would cause a further rise in the prices of oil and natural gas and also due to disruptions in the supply of other commodities, particularly edible oils. Prices of palm oil, soya oil, sunflower oil and vanaspati have already increased across the country due to supply shortages and also because of increased demand during the festive season.


The crude oil price has already reached US$ 140 per barrel which was US$ 84.65 per barrel (year high) and US$ 47.62  (year low) last year and India‚Äôs import dependency for crude oil on a consumption basis is more than 85 per cent. In spite of the fact that the import volume of crude oil has declined during the recent past due to the low activity levels during the pandemic but import bills increased due to rising oil prices. For the period 2015 to 2020 international crude oil price was relatively low with an average of yearly high valueswas US$ 63.79  per barrel. The retail selling price of petrol in Delhi was Rs 95.41 per litre and diesel was Rs 86.67 per litre although it has been higher in other metro cities. What is important is that currently 45.5 per cent of the retail price consists of central and state taxes and in the case of diesel it is about 39.8 per cent. Since it is not easy to avoid the use of fuel even if prices increase, the rise in prices of fuel actually added revenue to the government exchequer.
 In fact, the collection of central excise duty levied on petrol and diesel more than doubled from Rs 1.78 lakh crore in 2019-20 to Rs 3.72 lakh crore in 2020-21. The incidence of tax on petrol and diesel includes basic central excise duty, special additional excise duty, road and infrastructure cess and agriculture and development cess. At present 96 per cent of tax on petrol and 94 per cent of that of diesel comprises of surcharge and cess and since only revenue collected in the form of excise duty is shared with the states and not the cess and surcharge component, the devolution of revenue collected from petrol and diesel to the states have declined over the years.


A rise in petrol and diesel prices will be having cascading effects on prices of non-fuel commodities as well and all taken together will increase inflation leading to a fall in the real income of people, particularly those whose income is not inflation-indexed. In a recessionary situation, this will further reduce consumption demand making the recovery process from the pandemic even slower. Since the current inflation is mostly driven by rising input costs, particularly commodity prices and fuel, if the tax rates remain the same and the rise in crude oil prices are entirely passed on to the consumer it will essentially redistribute income in favour of the rich.
It is also important to note that even if the government was able to mop up higher revenue due to rising fuel prices that did not lead to a proportionate increase in government expenditure. Instead in the last budget, there were huge cuts in expenditure on employment-generating programmes and welfare schemes, which essentially means even if people, in general, had to bear the brunt of rising prices but the revenue collected out of that was not actually used to offset the consequent fall in their real incomes. On the other hand, big corporates could sail through due to their big pockets and could outcompete the smaller players in the market. Their sales value increased during this period and in many sectors, the manufacturers have already indicated that sale prices will be increased to protect their mark-ups. Depending on the market power corporates will be trying to retain or even increase their profits but because of sluggish demand in the economy will not be able to utilise their capacities. Relatively smaller producers would find it difficult to sustain and that is going to reduce jobs further.
It will end up with increasing prices, low demand and rising unemployment. In such a scenario when tendencies of stagflation seem to be looming large government expenditure needs to be directed towards the poor and instead of increasing excise duties on petrol and diesel it should be cut down to protect the vast majority of working people who otherwise are left with no institutional mechanism to protect their incomes.