Russia-Ukraine Conflict: A Protracted War of Economic Devastation

Government Raises Fuel Prices to Manage Economic Fallout

The Indian government has hiked fuel prices for the second time in a week to manage the economic fallout of the West Asia conflict. The rupee is under pressure due to elevated crude oil prices and heightened losses at oil marketing companies, which are exerting pressure on public finances.

Fuel prices have been increased by less than Rs 4 per litre till now, against an estimated requirement of more than Rs 13 per litre. The lower and slower price hikes are delaying the inevitable demand side action in the market, as economic theory suggests that price hikes nudge users to consume less.

A welfare-focused country such as India may not be able to drastically raise prices. However, with war damaging oil infrastructure in the Middle-East, chances of quick normalization in global fuel supplies are dim. Therefore, it is no longer the time to display reticence.

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As it is, continued demand for and imports of crude oil are accentuating pressure on key economic indicators, which can pull the country into a vicious cycle of currency weakness and inflation. A continuous depreciation in the rupee nullifies price hike benefits for fuel retailers, making it challenging for the government to manage fiscal deficit and inflation simultaneously.

According to Kotak Institutional Equities, the government faces a difficult task of managing fiscal deficit and inflation simultaneously, and it can do little about the current account deficit/balance of payments in light of large structural trade and current account deficits and weak FPI interest in India.

The rising energy prices are not just fuelling inflation in India but across the globe. Bond yields are rising, and investors are bracing for interest rate hikes by the Reserve Bank of India, which can raise borrowing costs for all – corporates, government, and retail consumers.

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Amid the intensifying economic headwinds, one cannot but help wonder if India would do better by enabling freer transmission of crude oil prices at fuel pumps. This will lead to cost pressures, but can also help alleviate some of the pressure on macroeconomic readings.