Global crude oil prices are once again reaching a level that could twist the knife on government finances. Early this week, Brent crude prices breached $87 per barrel—touching the highest point since 2014. Forecasters estimate prices to crack $100 per barrel during the current quarter and even though similar predictions were made in the past seven years, there were no nasty surprises. Yet, the current projections are chilling given the precarious economic recovery and persistent inflation. The latest spike, driven by an outage on a pipeline from Iraq to Turkey, shows growing unrest in the oil-producing West Asian belt and adds to an already tightening supply conditions. This made markets freeze citing inflationary pressures and anticipated rate hikes.
The volatile, imperfect and transitory nature of oil prices is well known, yet the current rally calls for additional vigil from both the government and RBI. Any further increase from the current level of oil prices will strain the fiscal deficit as the Centre’s hands are tied due to Assembly polls in seven states. It will be forced to absorb the price shock. As it is, petrol and diesel prices remained unchanged since December, though crude prices shot up 24% from $70.56 to $87.51. In contrast, expectations are running high that the Union finance minister could use the upcoming Budget to further reduce fuel taxes and grease the wheels of the economy.
So far, oil taxes lent a helping hand filling up the coffers. For instance, even when global crude prices fell, the government cashed in with tax hikes and as a result, net oil revenues (taxes minus subsidy) accounted for 28% of total tax collections in FY21, up from 18% in FY19. If global prices cool off, a thankful government may well reduce duties without affecting its revenue math and ease the inflationary burden on households. But any further rise from the current level could be disastrous for the economy and will put pressure on inflation, current account deficit, bond yields and exchange rate, which in turn will force the central bank to raise rates prematurely.