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Introduction
The Crude Oil Prices have steadily increased over the past decade.
AGGREGATE DEMAND
AggregateDemand
HouseholdConsumption
(C)
GovernmentConsumption
(G)
Net Exports
(X)
Private
Investment(I)
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In Rupee terms
Imports have increased reducingthe Net Exports (X) component ofaggregate demand.
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Impact on Household Consumption (C)
Affects the Cost of Production
DieselTrucks and Railways, fertilizers and pesticides for
agriculture, plastic-manufacturing
Major Contributor to Cost Push Inflation
Prices of Products are partially increased to Offset production costs
High Inflation with negative sentiments to future prices led
to decrease in household consumption
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Impact on Government Consumption (G) Cushioning effect though fuel price subsidies
Administered Pricing Mechanism
Increases the government expenditure
Partial pass-through of price rise cushions the fall in household disposableincome, which has a positive impact on Aggregate Demand
However this is not sustainable in the long term considering the supply sidebottlenecks and the rising Fiscal Deficit
In Long Term its advisable for the Government to reallocate the money
used for subsidy to more productive channels, like incentivizing the searchfor Crude Oil sources domestically
Government can also attempt Long-term capital formation throughinfrastructure development
Private Investment has reduced due negative business expectations due to
Decreasing Aggregate Demand
Persistently high interest rates
Impact on Private Investment
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Overall Impact and RBIs Monetary Policy stance
Reduction in GDP growth rate -higher unemployment levels
Cost-Push Inflation has hit the BOP hardest
Situation of Stagflation
RBI had hiked the Repo Rate 13 times along with CRR hikes
Fight inflation by sucking the liquidity in the market
Control Demand side
Current inflation is mainly due to supply side and not a demand side inflation , thus
rendering the above measures ineffective
Fuel and Food major contributors to inflation
With supply side constraints, the impact of monetary policy is minimal
Cost-Push policy can be countered as reducing demands will force the manufacturers
to reduce the mark-up to increase the demands
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Transmission of International Oil
Prices to India
The three broad channels through which the international oil prices have a
deep impact on the economy are
a) Import Channel
b) Price Channel
c) Fiscal Channel
Import Channel:
India is a Net Importing Country
Susceptible to foreign bill variations Rise in Oil prices means real growth reduces
The Compression in aggregate Demand dampens the Growth
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Price Channel
Price channel is indicated by the link from international oil prices to
increase in administered prices to WPI inflation
The objectives for regulation of price of oil have been three-fold:
To protect the domestic economy from volatility in international oil
prices
To provide merit goods to all households,
To protect poor consumers so that they may obtain kerosene (through
PDS) and LPG at affordable
If the administered price of crude oil, gas and petroleum increase by 7 per
cent,
The overall WPI increases by 1 per cent (i.e. the total elasticity to be 0.14)
10% increase in Global Prices1 %point increase in WPI and 2% over
time
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Fiscal Channel
Absence of a complete pass-through, an international oil priceincrease will raise the subsidy on oil
Increase the revenue expenditure of the government
Oil prices though subsidized also generate revenue for both stateand centre
A rise in international oil prices affects the tax collected
The Tax Collections should however rise to result into a net addition into
the subsidy
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2.8 % of the GDP
Over 60% of State Exchequer
3 years Tax contribution has been higher than the subsidies provided by the
government
Contribution: Rs 136,000 crore and state 80,000 crore
Subsidy including Oil Bonds Rs.40,000 Crore
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International Comparison ofPetroleum Prices
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The table shows:
Price of all products except kerosene are higher than international market
This is applicable to the subsidized diesel
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The table below compares prices of petrol with other countries
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Break up of Retail Prices
Taxes are close to 50% of retail price
More than 50% of taxes are collected in form of Excise
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Projection of Financial Burden on
India
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The table above shows the projected consumption by 2020-21 and 2030-31
The two assumptions made in Kirit Parekh Report (2010)
The average annual compound growth rates of petrol diesel kerosene LPG during 2002-3 to2008-09 will apply to 2020-21 & 2030-31
The Current Level of prices set by government will continue
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The Figure below represents under-recoveries of OMCs on sale of petrol
diesel LPG and PDS Kerosene
These estimates reveal the share Diesel in Under-Recoveries and is
Projected to Increase from 45% of Crude to 58% at $150/barrel by 2020-21
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Financing the Under-Recoveries Significant impact on oil companies, notably the upstream national oil
companies
They are currently shouldering the majority of the nongovernment burden
On Elimination ,money would allow the companies to be properly andfairly financed
One way to finance part of the under-recoveries is to levy a windfallprofit tax on all upstream companies who were allotted blocks onnomination basis
The Chaturvedi Committee has suggested a special oil tax on domesticproducers of crude oil on pre-NELP leases
100% from a price level of $75/bbl so as to manage the huge under-recoveries
estimated for 2008-09. The tax should be either
(i) annulled
(ii) re-set downwards to equal the fuel subsidies made available only to BPL families for SKO andLPG
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Conclusion & PolicyImplementation
International oil price shock is expected to result in lower growthand higher inflation, via the trade channel, the fiscal channel and the
price channel
More substantial reforms are needed, including full deregulation of
diesel prices, and periodic increases of domestic liquefied petroleum
gasoline (LPG) and Public Distribution System (PDS) keroseneprices
Harmonize petroleum sector taxation with the proposed goods and
services tax (GST) in the framework of a tax on value-added
Reviewing and improving the tax system would yield a range of
benefits for the Indian economy, but can be seen as a medium- tolong-term measure
It is possible to proceed with diesel subsidy reform without changes
to the tax system
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Conclusion
Reforming fuel subsidies would improve Indias fiscal balance
Create fiscal space for increased investment in physical and social
infrastructure or other development-related expenditures
This will remove current market distortions (such as the growing number ofprivate vehicles being manufactured to run on diesel)
Incentivize energy efficiency and clean energy solutions, thereby reducing
pollution levels
Removing fuel subsidies entirely would also remove opportunities for
corruption and selling fuel on the black market
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Thank You