IMPACT OF CRUDE OIL PRICE ON INFLATION

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1 IMPACT OF CRUDE OIL PRICE ON INFLATION Impact of crude oil price rise to be relatively muted in CPI inflation as compared to WPI inflation OVERVIEW JUNE 216 The price of the Indian crude oil basket has started firming up in recent weeks after having declined sharply from an average of above U$ 1/barrel in Q2 FY215 to US$ 32/barrel in Q4 FY216. The impact of rising crude oil prices on WPI and CPI inflation in FY217 would be influenced by the extent of pass through to domestic retail prices of fuels and the degree to which the earlier excise hikes on petrol and diesel are reversed. Nevertheless, the impact would be relatively muted in CPI inflation as compared to WPI inflation. In our view, factors such as the extent to which monsoon dynamics are successful in dampening food inflation would have a greater role in determining the trajectory of CPI inflation as well as the magnitude of future rate cuts. Contact: Aditi Nayar aditin@icraindia.com The average price of the Indian crude oil basket moderated considerably from U$ 12/barrel in FY214 to US$ 84/barrel in FY215 and further to US$ 46/barrel in FY216. From the lows of US$ 32/barrel in Q4 FY216, the average price of crude oil has risen to US$ 45/barrel in May 216. Lower crude oil prices transmitted speedily into wholesale inflation, but had a limited first-round effect on the Indian CPI that is dominated by food and various services. Table 1: Weight of Crude Oil, Mineral Fuels and Fares in the CPI and WPI WPI CPI Item Weight Item Weight MINERALS 1.5% FUEL AND LIGHT 6.8% Crude Petroleum.9% LPG [excl. conveyance] 1.3% FUEL & POWER 14.9% kerosene PDS.3% MINERAL OILS 9.4% kerosene other sources.2% LPG.9% Diesel [excl. conveyance].% Petrol 1.1% other fuel.2% Kerosene.7% MISCELLANEOUS 28.3% Aviation Turbine Fuel.3% Transport and communication 8.6% High Speed Diesel 4.7% petrol for vehicle 2.2% Naphtha.8% diesel for vehicle.1% Light Diesel Oil.1% lubricants & other fuels for.1% Bitumen.2% other conveyance expenses.% Furnace Oil.5% railway fare.2% Lubricants.2% bus/tram fare 1.4% taxi, auto-rickshaw fare.6% school bus, van, etc..2% air fare (normal): economy.1% steamer, boat fare.% Source: Central Statistics Office (CSO), Office of the Economic Advisor, Ministry of Commerce & Industry, GoI; ICRA research ICRA LIMITED P a g e 1

2 The weight of crude oil in the WPI stands at.9% (refer Table 1), whereas mineral oils have a substantial 9.4% weight in that index. On the other hand, while crude oil does not feature in the retail basket, various mineral fuels 1 and fares 2 are included within the fuel & light and transport & communication sub-indices of the CPI (monthly inflation rates for these items are available from January 215 onwards). The weight of mineral fuels and fares in the CPI Index stands at a relatively modest 4.4% and 2.5%, respectively, as estimated by ICRA. The pace of transmission of crude oil price movements into prices of mineral fuels and subsequently into fares, thus has a differential impact on WPI and CPI inflation. Chart 1: Movement in Prices of Crude Oil, Petrol, Diesel and ATF Rs./bbl 5, 4,5 4, 3,5 3, 2,5 2, 1,5 Rs./litre RSP for Petrol in Delhi on the 1st of each month (RHS) RSP for Diesel in Delhi on the 1st of each month (RHS) Source: PPAC, GoI; ICRA research Price of ATF for domestic airlines in Delhi on the 1st of each month (RHS) Average monthly price of Indian basket of crude oil (LHS) The extent and speed of transmission of the movement in the price of the Indian crude oil basket has varied across the domestic prices of different fuels. For instance, transmission to output prices has been relatively fast for fuels with market-linked pricing, such as aviation turbine fuel (ATF; refer Chart 1). The price of ATF (for domestic airlines) in Delhi 3 nearly halved Rs. 62.5/litre on November 1, 214 to Rs. 35.1/litre on February 1, 216, before rising to Rs. 42.8/litre on May 1, 216. While prices of petrol and diesel (combined weight of 5.8% in the WPI Index) were deregulated by the GoI in 21 and 214, respectively, the hikes in excise duty imposed by the Union Government on these fuels (Rs. 12/litre and Rs. 14/litre, respectively, in various tranches since November 214; refer Chart 2) moderated the pass through of the fall in crude oil prices movements into the retail prices of these fuels. Moreover, upward revisions in VAT rates introduced by some State Governments have added to the cost of fuels. For instance, the price of petrol in Delhi eased somewhat from Rs. 64.3/litre on November 1, 214 to Rs. 56.7/litre on March 1, 216 before reversing to Rs. 62.2/litre on May 1, 216. In a similar trend, the price of diesel fell from Rs. 53.4/litre on November 1, 214 to Rs. 44.7/litre on February 1, 216, before rising rapidly to Rs. 51./litre on May 1, 216. However, transmission has been muted in the case of fuels such as kerosene and LPG (combined weight of 1.7% in the WPI Index), which continue to be provided at subsidised prices to a section of consumers. Nevertheless, these two items comprise a relatively small proportion of the mineral oils basket of the WPI Index (weight: 9.4%). 1 Inclusive of LPG, kerosene, diesel, petrol, lubricants and other fuels. 2 Inclusive of fares for railway, bus, tram, taxi, auto-rickshaw, school bus, van, airplane, boat and steamer, and other conveyance expenses. 3 The decline varies across States based on the rate of tax levied by the State Governments on different fuels. ICRA has considered prices as on May 1, 216 in this note, since the WPI and CPI inflation data is available up to April 216. ICRA LIMITED P a g e 2

3 Chart 2: Increase in Excise Duty on Diesel and Petrol Rs./bbl 6, 5, 4, 3, 2, 1, Rs./litre Increase in Excise on Petrol (RHS) Increase in Excise on Diesel (RHS) Average crude oil price (Indian Basket; Rs./Barrel) in preceding fortnight (LHS) Source: PPAC, GoI; ICRA research Owing to the overall weight and the contribution of fuels with market-linked pricing in the WPI, the fall in prices of crude and mineral oils has had a considerable impact on WPI inflation from November 214 onwards (refer Chart 3). The drag exerted by these items was crucially responsible for the sub-zero WPI inflation for 17 consecutive months from November 214 to March 216. Going forward, a sustained rise in prices of crude and mineral oils is likely to be transmitted fairly quickly to WPI inflation, especially if the GoI chooses not to cut the excise duty on petrol and diesel. While the latter provide a substantial cushion to the Government to dull the inflationary impact of rising crude prices, a cut in excise duty would adversely impact the growth of the GoI s revenue collections. Nevertheless, moderately healthy volume growth of consumption of petroleum products would partly offset the impact of excise cuts. Chart 3: Composition of WPI Inflation 8% 6% 4% 2% % -2% -4% -6% Crude Petroleum Mineral Oils Other WPI Crude (US$/barrel; RHS) Source: Office of the Economic Advisor, Ministry of Commerce & Industry, GoI; ICRA research ICRA LIMITED P a g e 3

4 The fall in CPI inflation since early-214 has largely been driven by food and housing inflation. The drag imposed by mineral fuels on the CPI has been quite limited (refer Chart 4), given the type of fuels and fares included in this index. For instance, regulated fuels that have not witnessed much change in retail prices for the subsidised segment, such as PDS kerosene and LPG, have a substantial combined weight of 1.6% within the mineral fuels basket (weight: 4.4%) of the CPI Index. Moreover, petrol and diesel have a combined weight of 2.3% in the CPI, whereas items such as ATF are, as expected, not included in the retail basket. In addition, fares (weight: 2.5%) are dominated by bus/tram fares (weight: 1.4%), which tend to be closely regulated by State Governments. In contrast, the combined weight of taxi and air fares, which would be far more sensitive to changes in fuel prices, is less than.7%. As a result, the first round impact of crude oil prices into the CPI has been relatively limited in the past. To the extent that retail fuel prices have firmed up, higher transport costs have led to some second round impact into the prices of various goods. In our view, even if the GoI chooses not to cut the excise duty on petrol and diesel going forward, the impact of higher crude oil prices into CPI inflation would be limited. Moreover, factors such as the extent to which monsoon dynamics are successful in dampening food inflation would have a greater role in determining the trajectory of CPI inflation as well as the magnitude of future rate cuts. Chart 4: Composition of CPI Inflation from January 215 highlighting impact of Mineral Fuels and Fares 7% 6% 5% 4% 3% 2% 1% % -1% Source: CSO; ICRA research Mineral Fuels Fares Other CPI Crude (US$/barrel; RHS) ICRA LIMITED P a g e 4

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