Deregulation of Oil Prices Raises Concerns for RBI's Monetary Policy Challenges

Fuel Price Hikes: A Growing Concern for India's Economy

Oil marketing companies in India have announced a Rs 3 per litre hike on petrol and diesel prices, effective May 15, marking the first price revision in retail fuel rates in nearly four years. Just four days later, on May 19, another price hike of about 90 paise was announced.

India deregulated its oil economy more than a decade ago, with petrol prices being deregulated in 2010 and diesel prices being deregulated in 2013. However, retail prices are still heavily influenced by the government, and oil marketing companies must absorb the losses when crude prices surge.

Market experts believe that a complete deregulation of prices would make the Reserve Bank of India's (RBI) job tougher, as inflation management and fiscal priorities determine monetary policy. They argue that fuel price deregulation would allow oil marketing companies to pass on the price to consumers at more regular intervals, rather than making it ad hoc as the government has made it.

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The RBI's Inflation Challenge

A fluctuation in fuel prices can have a direct bearing on inflation, and consequently on repo rate fixing. From the RBI's perspective, a deregulation in crude oil prices could lead to fluctuations in assumptions for inflation. Analysts from Crisil expect CPI inflation to rise to 5.1 percent on average in FY27, up from 2.0 percent in FY26.

The inflation print in April came in at 3.48 percent, as compared to 3.4 percent in March. Although it is within the RBI's mandate of between 2 percent and 6 percent, any sharp spike in CPI may warrant a rethink by the central bank on the trajectory of interest rates.

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The Impact of Fuel Price Hikes

Every Rs 1/litre increase in petrol and diesel prices can add nearly 4-6 bps to headline CPI inflation over time. As a broad rule of thumb, a Rs 5-10/litre increase in fuel prices can lift CPI inflation by nearly 0.20-0.30 percent over the following months. Fuel and electricity account for roughly 6-7 percent of India's CPI basket directly, making it unusually sensitive to external oil shocks.

The Global Context

Even developed economies such as the United States are facing the pricing pinch. "In the US, we've already seen gasoline prices going up, and there is a pretty direct impact on inflation and on consumers also," said Lavanya Venkateswaran, an economist with OCBC Bank. The volatility in Brent crude prices at this moment makes the prospect of a possible rate hike in the coming months difficult to ignore.

What Happens When Crude Prices Cross $150 per Barrel

Although there is no certainty that Brent crude prices will cross $150 per barrel, one can never rule this out. If crude jumped from the current $100 range to $150 and stayed there for several months, the RBI is likely to raise its crude price assumptions. Economists are already pencilling in that the average crude price assumptions will be near $95 per barrel for FY27.

For India, the consequences would be felt across inflation, growth, the rupee, and monetary policy, since it imports nearly 85 percent of its energy needs. A sustained move towards $150 per barrel will result in a significant macroeconomic shock, stall growth, and put enormous pressure on the current account, inflation, and the rupee.