“Raise in petrol price”

Why govt raise petrol prices

There has been lot of argument on the government raising the price of petrol in india by rs 7.5-8/ ltr. Of course for a common man it is certainly a huge Burden. But there is a matter to think on a sudden 7.5-8 rs increase on petrol price by government. Do you think for no reason government think to raise prices like this? The answer is

no.

As we all know rupee has depreciate by more than 6-7 rs in comparison to greenback at the end of this month and a so. This has create a huge amount of pressure for government to make rupee strong vs dollar. For the same reason government has started taking steps from September itself when they come up with $845 million but that was not enough to stop the depreciating rupee, month before also they have use alternatives to stop it like they suggest exporter to sell their dollar to importer so that they don’t demand it from market for their payment and rupee will appreciate. But all these are sort term measures to stop rupee falling.

But lets come to the point that why government need to raise oil price in that?

These are all measures to support india rupee and it has a direct impact on the payment of oil Indian company need to make for their buy of each barrel of crude oil. For that we need to first 

understand how rupee depreciate its value:

There are various parameters on the basis of which the value of currency( specially Indian currency) decided6

-current account deficit

-policy parameters of country

-foreign investment etc

These all factor maintain the supply-demand balance of currency for example

If our country have huge amount of deficit( which is 4.6%of our GDP right now) than we need to borrow money from other country most probably it comes from USA. Which in turn increase the demand of dollar in our country and because the supply is not that high( because we made a sudden demand) the price of dollar will go up against our currency.

Let say FII’S(foreign institutional investment) and FDI’S(foreign direct investment) is very less in our country due to the fact that our fiscal and cuurent account deficit is high and institution and companies of foreign feel that they may not be in position to repay our investment or may generate less return than they can earn investing in some other country. And if the fii’s and fdi’s in country is less there would be less inflow of dollars in our market as compare to our demand to fulfill the demand of dollar for the payment of import bill. In that case rupee will depreciate its value.

Other point is te policy parameters of country, if the monetary as well as fiscal policy of country in not good in the sense that which could attract foreign investor to invest in Indian market.   for example: The previously proposed GAAR (General Anti-Avoidance Rule), which could have caused foreign investors huge tax liabilities despite investing through so-called tax-friendly jurisdictions, is estimated to have led foreign investors to withdraw or put on hold investments worth over $10 billion within just over a month of being announced. And as we have discussed if foreign investment is not coming ( as in dollar is not coming) than currency value will decrease.

Now having understood how currency depreciate its value not lets understand what is the

Impact of depreciation of currency:

     1.     Increase in the Import Bill

A depreciation of the local currency results in higher import costs for the country. Failure of a similar rise being experienced in the prices of exportable commodities is going to result in a widening of current account deficit of the country.

For example: if you have bought 1 barrel of crude oil on 31^st may 2011 at $100/barrel at Indian rupee 50/$, you need to pay 100*50=5000rs, now in the similar case if rate of Indian rupee is 58/$than you need to pay 100*58=5800rs. Which certainly increase you cost by 800rs/ barrel.

     2.     Higher Inflation

 Increase in import prices of essential commodities such as crude oil, fertilizer, pulses,edible oils, coal and other industrial raw materials are bound to increase the prices of the final goods. Thereby making it costlier for the consumers and hence inflation might be pushed up further.

3. Fiscal Slippage

The central government fiscal burden might increase as the hike in the prices of imported crude oil and fertilizer might warrant for a higher subsidy provision to be made for these commodities.

More understanding of it can be drawn from the tables below:

Scenario 1: import bill valuation using prevailing exchange rates for the respective months.		Scenario 2: import bill valuation using April 2011 exchange rates for the respective months.
Month	Value of import (Rs.crore)	month	Value of import(Rs.crore)
April 2011	160536.6	April 2011	160536.6
December 2011	226535.6	December 2011	190495.8
Increase in import bill	65999.0	Increase in import bill	29959.2

From the above table we can see that due to rupee depreciation import bills in the

above two situations differ by Rs. 36039.8 crore.

Observation: From Table 1&2 we can see that in case of Petroleum crude & products

(Appendix)

• Import bill of petroleum crude & product have declined in international

currency in December as compared to April 2011.

• However, in terms of domestic currency, the import has increased.

Therefore the rupee depreciation has made import of these commodities expensive.

The importers have to pay an additional Rs. 489.8 per barrel to import

the same quantity of Crude Oil.

                                        

Now having understood the impact of currency depreciation on crude oil and import prices

Lets move on to the question we have raised earlier that why government raised petrol prices:

We know that if government is running in deficit or say a huge deficit of 4.6%of its GDP  the value of their currency will certainly fall and due to that country has to look at the reduction of this deficit, and taking into consideration of this government of india has said in the budget 2012 that they want to decrease this deficit.

And subsidy on fuels, fertilizers,and food these are the commodities cover 2.5%of india’s GDP.

so out of 4.6% of total deficit 2.5 % is being contributed by these 3 things which government like to decrease if india wants to grow like it was growing in 2009-10 at near 9 % growth with Indian rupee is strong at 44/$ india has to decrease these subsidy.

Talking about the current scenario subsidy on oil in budget 2012 is made 43600cr. And as we have seen the currency value of india is 57/$ which increase the import bill of india as well as the government need to provide more subsidy on oil which they cant because it further increase the deficit of country. If they don’t give subsidy to companies companies will make huge losses. So if they increase the petrol prices companies will not have to face losses government will not give further subsidy which helps them maintain deficit which will help stopping the gradual decrease in rupee value and rupee will become stronger.

But is this the only option:

No it is not the only option government will take other steps to making rupee strong against dollar:

1-Dollar bond issue:

India can go for issuing sovereign bonds which can fetch dollar in india and government can increase its foreign currency reserves and oil company can easily pay their expenses.

But the real problem here is it will further increase government deficit which is a sign of decrease in growth and future devaluation of Indian currency.

2-increase interest rate :

Government can go for increase in interest rate which will help government to reduce inflation.

3-relife in FII’s policy:

As we have discuss before if government allow FII’S in some sector of india and give slight relief from GAAR. It will bring more foreign currency in india and rupee will further be strong enough. but seems to be very important decision for government for this matter.

Though exporter get benefit of reduction in the value of currency but it only increase the deficit because india is having more import than export.

These graphs will give us better idea of how india has become import oriented country:

We can see that for an export of 28000 million usd or so we has made an import 40000 million usd a difference of 12000 million usd in first quarter of 2012.

Of course increase in petrol price will certainly look like an inflation oriented decision of government of india but  it is not People might be thinking of an inflation which take place by raise in petrol price but either way if rupee get depreciated like this only and reach 60/$ than other importer like electronics, Thermal Coal, Fertilizer, Vegetable oil, garments, food, chemicals ,leather, steel, machine parts, etc they have to pay more in their import and that way also inflation will increase with dollar remain 60/$ as well as government deficite above the repaying capacity of government which will further increase the prices (inflation) lead to unemployment, decrease in GDP etc.

Summary: so as far as the situation of India is concern this is a better or say only step government can take for this problem of economy it will certainly benefit government, oil companies other industries. Of course for an individual or a common man it is a problem for short term but in long term it will be beneficial for them too because it will avoid long term inflation and lead to growth of a country.