GDP, inflation, and petroleum pricing

Nothing short of a dilemma faces this government. Petroleum price question is going to test the nerves and promises to give sleepless nights to the authorities, if oil prices projections currently being made hold true. The dilemma goes beyond the most obvious revenue question. Increase the price and pocket some tax revenue and risk facing low petroleum consumption. Don’t do that, and the elastic nature of petroleum products could inflate the import bill.

What to do? The answer will lie in what the priorities are for the remaining tenure. Like it or not, petroleum prices remain a largely political decision. What is crystal clear at this point is that the government has set two priorities going forward. Higher growth and controlled inflation. How does that fit into the petroleum pricing and demand equation is the point to ponder.

The demand elasticity of petroleum products, especially gasoline is well registered – and barring exceptions, it has largely followed the pattern for the past many years. In simpler words, raise the price, and see demand (or demand growth) coming down. Let us assume there is no subsidy at play here, and petroleum taxes continue to remain the main lever. This scenario will fetch more revenue, even at suppressed demand growth.

But it fuels inflation too, and that contradicts with government’s priority number one. Not that all of it is under government’s own control. For instance, if oil prices rise to a certain point, where even no taxes mean higher prices, then too bad. But don’t expect the government to jack up prices as long as it is inflation control is a top priority. Not that it does not have fiscal consequences. But that is precisely why it is a dilemma.

Now on to the growth aspect. When higher prices lead to lower consumption – it hampers growth. The GDP-petrol consumption has religiously followed a strong pattern over the years. Cause and effect can be left for some other day, but high petroleum growth has invariably led to higher GDP growth, and lower consumption has yielded lower GDP. There have been no exceptions to the trend in the last ten years.

So, raising prices hamper both the government’s newly set priorities – growth and inflation. Not raising them could spell fiscal trouble. Will the government go for its priorities and sustain as much as it could? Will fiscal consequences have a bigger say? Whichever way it goes, it will have lasting consequences. Here is hoping whatever decisions are taken, are well-calculated, informed, and in-line with the near-term objectives of sustainable growth and controlled inflation.