H I G H L I G H T S
• India’s oil sector policy hit by Russia-Ukraine conflict
• Retail inflation management would cause concern
• Govt choices limited as agri-commodities prices will go up
• Impact on government finances may be manageable
• Question mark over consumer spending and pace of recovery
• Real estate, construction, cement to be hit by higher prices
• RBI monetary policy maintains stance with no rate hike
• Move towards simplifying capital gains taxation structure
• Exports maintain growth, but pace slows, deficit widens
• Registration of passenger vehicles and two-wheelers declines
• Monsoon prospects good and fuel demand forecast looks up
India’s oil sector policy hit by Russia-Ukraine conflict
The first casualty of the Ukraine crisis is India’s oil sector. International crude oil prices have already shot up by over 22 per cent in the past four weeks to cross $105 a barrel. According to an estimate made by the country’s largest bank, the State Bank of India, retail prices of petrol and diesel should have gone up by about Rs 9-14 a litre, based on the existing taxation structure and the assumption of international crude oil prices ruling at about $100-110 a barrel. However, retail prices of both petrol and diesel have remained unchanged since November 2021, most likely because of the Assembly elections in five states. Retail petrol and diesel prices may be raised after the Assembly election results on March 10, but the oil companies would have already taken a hit in the last four months. This is not good news for the finances of India’s state-owned oil companies. Equally important is the message it has for the prospects of privatising Bharat Petroleum Corporation Limited or BPCL. Even though retail petroleum product prices are no longer administered by the government, in reality retail fuel prices are influenced by the government’s political and populist considerations. Thus, there is a big question mark over BPCL’s privatisation. If the government does not allow real pricing freedom for the state-owned oil marketing companies, which has the largest share in total retail sales in India, BPCL even after privatisation may not be able to pass on the impact of increased crude oil prices in the form of higher retail prices of petroleum products. That will depress BPCL’s valuation from the perspective of its potential private-sector acquirer. The Ukraine crisis has underlined the fault lines in India’s oil sector and the need for genuine retail pricing reform to improve the finances of existing oil marketing companies as also to enhance prospects of privatising state-owned oil marketing companies.
Retail inflation management would cause concern
The impact of the Ukraine crisis will be no less significant on the government’s inflation management challenges. With international crude oil prices expected to remain elevated at over $100 a barrel, the pressure on the government and oil marketing companies to raise retail prices of diesel and petrol would increase. It would of course be difficult to pass on the entire burden of higher costs to the consumers. An increase in retail prices by over 10 per cent would be needed to recoup the losses oil marketing companies would have incurred since international crude oil prices went up. Such a steep price correction seems unlikely. Retail inflation, measured by the movement in the Consumer Price Index, rose to a seven-month high of over 6 per cent in January 2022. This was higher than the Reserve Bank of India’s upper tolerance band. Retail inflation had begun to rise from November, when it was measured at 4.91 per cent. In December, it rose to 5.59 per cent and the January figure of 6.01 per cent had not fully absorbed the impact of the Ukraine crisis and consequent crude oil price increase. Several economic analysts have projected that the Russia-Ukraine conflict would raise retail inflation in 2022-23 to 4.7-5.2 per cent, higher than the estimate of 4.5 per cent, made by the RBI Monetary Policy Committee. It is estimated that a 10 per cent increase in crude oi prices pushes up inflation by 0.3 to 0.4 percentage point. Aditi Nayar of ICRA, a rating agency, projects retail inflation to be around 6 per cent in February. Endorsing such a view, D.K. Pant of India Ratings believes that if the Russia-Ukraine conflict goes on for a while, retail inflation would cross the 6 per cent mark.
Govt choices limited as agri-commodities prices will go up
Retail inflation will also be adversely impacted by an increase in global prices of agricultural commodities, particularly those of wheat, barley and corn. Remember that Russia and Ukraine account for about a fourth of the total world trade in these grains. The two countries also account for over half the global trade in sunflower products and about 21 per cent of rapeseed. Sanctions on such products would push up global prices of these commodities as their demand is inelastic. Retail inflation in India is also likely to move up as a result of the movement in global prices of such agricultural commodities. The government will thus be more focused on managing the inflation on account of higher energy prices. Consequently, it may not be able to allow the entire impact of higher crude oil price increases to be passed on to the consumers. Instead, it could be a mix of a moderate increase in retail prices and a reduction in central taxes on the sale of petrol and diesel.
Impact on government finances may be manageable
If the government has to moderate the impact of higher retail fuel prices on overall inflation, its own finances will have to take a hit. An analysis by SBI shows that if petrol and diesel taxes are reduced appropriately to keep the retail prices of these products unchanged, the monthly revenue loss for the Centre would be about Rs 8,000 crore, assuming that the international crude oil prices hover between $100 and $110 a barrel. For the full year of 2022-23, the revenue loss could, therefore, be about Rs 1 lakh crore, if the crude oil prices remain within that range for the whole of next financial year. This will be a substantial revenue loss. However, the tax revenue projections for 2022-23 have been conservative and the excise revenue loss on account of petroleum products could be absorbed by higher revenues under other heads.
Question mark over consumer spending and pace of recovery
Consumer spending too could take a hit, delaying economic revival. A survey conducted by LocalCircles, a social media platform, shows that about 42 per cent of households could slash their discretionary spending because of the Russia-Ukraine conflict. Worryingly, 24 per cent of these households are stated to have cut their spending already, fearing their inability to absorb the impact of a likely increase in retail prices of petrol and diesel. Finance Minister Nirmala Sitharaman did not underestimate the impact of the Ukraine crisis on the Indian economy’s growth prospects. In a statement, she expressed the hope that peace would return soon to ensure sustainable recovery. Her statement, however, reiterated the government’s commitment to work on the blueprint for development through investments for transition towards greener energy, investments for infrastructure, building of soft human power as well as hard, asset creation and greater investments in health and education, along with gender parity.
Real estate, construction, cement to be hit by higher prices
The real estate sector also will be adversely impacted by the Russia-Ukraine conflict. Continued tension in Europe would result in a rise in the cost of building materials, thanks to rising prices of crude oil and cement. In addition, interest rates are expected to firm up raising transportation as well as construction costs. It is likely that builders would increase prices of houses as a result of higher input costs in the wake of the Russia-Ukraine conflict. The national vice-chairman of the National Real Estate Development Council (NAREDCO), Niranjan Hiranandani, feared that higher fuel prices would adversely impact the cost of supply chains and logistics cost of raw materials, which eventually raise real estate prices, complicating the woes of an already troubled construction sector. Cement manufacturing too would be affected by higher oil prices. This would mean higher cement costs for the construction sector and the revival that was expected in the real estate sector in the coming months could prove to be elusive in the short term.
RBI monetary policy maintains stance with no rate hike
Ten days after the presentation of the Budget for 2022-23, the Reserve Bank of India completed its bi-monthly review of the monetary policy on February 10. The key policy rates remained unchanged and the policy stance continued to be accommodative to support what the RBI acknowledged to be an “uneven economic recovery”. The repo rate, at which the central bank lends to banks, stayed at 4 per cent. This was the tenth time in a row that there was no change in the repo rate or the cost of money. On keeping the repo rate unchanged, there was unanimity among all the six members of the RBI Monetary Policy Committee. But when it came to the stance of the monetary policy, the unanimity was missing. One of the members, Jayanth Varma, recorded his difference of opinion on the matter by asserting that the time to move away from an accommodative stance had come. The surprise was that there was no change in the reverse repo rate as well, at which the RBI borrows from banks. An increase in the reverse repo rate would have signalled the RBI’s intention to absorb the liquidity which was large in the banking system. It would have also signalled a change in the direction of the monetary policy, paving the way for an increase in the interest rates over the next few months. However, the monetary policy review was conducted before the Russia-Ukraine conflict broke out. Many of the assumptions in the review have been overtaken by subsequent events. The inflation projection of 4.5 per cent for 2022-23 will have to be revisited. Even the monetary policy stance will have to be reviewed in light of the Russia-Ukraine conflict and the higher crude oil prices. As for growth and the pace of economic recovery in 2022-23, the earlier RBI projections will have to be reassessed.
Move towards simplifying capital gains taxation structure
In what seems to be a ray of hope for fixing the taxation system, the government has indicated that it is willing to review the capital gains tax structure. The proposal if implemented can correct a basic inequity implicit in a concessional tax rate for capital gains on equity and also widen the tax base, as a result. In a recent media interaction, Revenue Secretary Tarun Bajaj has stated that the government could consider simplifying the capital gains taxation system, which at present is complicated because of the various rates in force depending on the period of holding these assets. At present, capital appreciation from an asset held for more than 36 months attracts a lower tax rate as these are considered long-term capital gains. Any capital appreciation from an asset held for less than 36 months attracts a higher tax rate as these are considered short-term capital gains. For equity shares or units of equity-oriented mutual funds, any appreciation in their value, if held for more than 12 months, is treated as long-term capital gains. House property has to be held for 24 months before any appreciation in their value could be treated as long-term capital gains. There are different methods for calculating the capital gains incidence on different kinds of assets and industry association, the Confederation of Indian Industry, has been asked to study the capital gains structure in different countries and in India and present a set of suggestions for the government’s consideration. If what Bajaj has indicated is indeed carried out, the Centre’s capital gains regime should become simpler and transparent. Both the stock markets and investors will keenly await the final word on this from the government.
Exports maintain growth, but pace slows, deficit widens
Merchandise goods exports by India in January rose by about 28 per cent to $34.5 billion, but its pace slowed compared to the record growth seen in December. The relief was that in spite of the surge in Omicron cases, India’s exports in January stayed above the $30-billion level for the eleventh month running, driven by an uptrend in outward shipments of engineering goods, petroleum products, gems and jewellery, chemicals, drugs and pharmaceuticals. With this, the government looks set to achieve the exports target of $400 billion in 2021-22. In the first ten months of the current year, merchandise goods exports are estimated at $336 billion, a rise of 46 per cent over the same period of 2020-21. Imports too saw sharp growth of over 23 per cent to $52 billion. Cumulatively, imports during April-January 2021-22 rose by 63 per cent to $496 billion. Trade deficit during the first ten months of the current year is already up at $160 billion and may exceed the peak level of $190 billion reached in 2012-13.
Registration of passenger vehicles and two-wheelers declines
Barring commercial vehicles, all other segments of the automotive industry saw the registration of vehicles fall significantly in January 2022. Registration of passenger vehicles fell by 10 per cent in January to 2.58 lakh units. The decline was largely attributed to a shortage of chips used in various components for passenger vehicles. Two-wheeler sales too saw their registration fall by 13 per cent in this period to about 10 lakh units. In contrast, commercial vehicles registration rose in January by over 20 per cent to about 68,000 units. These figures pertain to the vehicles’ registration with the state authorities and have been collated from the Vahan web portal, maintained by the government. Figures on registration provide a better indication of the retail sale of vehicles than the figures on the sale made by manufacturers to dealers or wholesalers. Tractors, whose sale figures are available, also saw a 28 per cent decline in January to 63,000 units. All is not well with India’s automotive industry as far as retail sales are concerned.
Monsoon prospects good and fuel demand forecast looks up
Indian monsoons in 2022 are expected to be normal, according to private forecaster Skymet. This should augur well for the economy in reviving rural demand, critical for sustaining overall recovery. Monsoons have been normal for the last few years. Any below-normal performance of the rains in 2022 could make the government’s challenges to manage inflation, revive rural demand and sustain growth even more formidable. Providing more comfort to the government, the petroleum ministry has indicated that the country’s demand for petroleum products would rise by 5.5 per cent to 214.5 million tonnes in 2022-23. This will mean that petroleum products consumption in the country would be returning to its pre-pandemic levels next year. In 2019-20, India had consumed 214.1 million tonnes of petroleum products. Aviation turbine fuel will see the biggest increase in consumption of about 50 per cent, riding on the resumption of civil aviation activities in most segments as the impact of Covid-19 on the economy recedes. Petrol consumption will go up by about 8 per cent, while cooking gas use would be up by about 5 per cent.
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(The views expressed are personal)