Crude oil prices at $110 a barrel pierces through RBI's oil estimates

The crude oil projections made by the Reserve Bank of India's (RBI) Survey of Professional Forecasters (SPF), which it has been doing since September 2007, have gone haywire.

Oil prices have touched a 10 -year high of $120 per barrel as geopolitical risks have increased manifold with Russia attacking Ukraine. The oil prices have now settled at $110 a barrel. Global banker JPMorgan Chase has even predicted crude to climb to $185 a barrel by the end of 2022.

In a survey of professional forecasters done by RBI two months ago, the crude oil price for the Indian basket was projected at $75 per barrel for the fourth quarter ( Jan-March) of 2021-22. The survey has forecasted a maximum price of $79 per barrel by March 2022.  

Similarly, the projection for the first quarter (April-June) of 2022-23 for crude was done at $77 per barrel and a maximum of $90 per barrel by June 2022. The current oil prices are way above the RBI’s projected levels. 

While the RBI's survey is not the view of the bank, but it does help in setting the monetary policy framework. 

Take for instance , the RBI has said that the retail inflation would be around 4.5 per cent in the entire year 2022-23 with an assumption that oil prices will remain below $75 a barrel. 

In order to support growth, the RBI has kept the policy rate benchmark, the repo rate, unchanged at 4 per cent for more than two years. The repo rate is the rate at which banks borrow funds from the RBI to meet their daily temporary mismatches. 

The RBI had kept the repo rate unchanged despite consumer price index (CPI ) being 5.3 per cent in 2021-22, which is closer to the MPC's higher band at 6 per cent. The RBI’s monetary policy committee (MPC) targets an inflation rate or CPI of 4 per cent with a band of 2 to 6 per cent.

The RBI's accommodative stance, as well as its moderate inflation forecast of 4.5 per cent for 2022–23, is now under threat. One of the six monetary policy committee members Prof Jayanth R Varma has been voting against the RBI's accommodative stance for the last nine months.

"India had no extraordinary monetary accommodation during the pandemic. Brent crude prices are uncorrelated with headline CPI inflation in India (because fuel & light have only a 6.84 per cent weightage in the CPI), but a generalised surge in commodity prices will likely keep India’s CPI inflation above 6 per cent year on year in Mar-Apr’22, nudging the RBI to raise the repo rate by 50bp in Apr-Jul’22," said Prasenjit K. Basu - Chief Economist of ICICI Securities in his recent report.

In the last year, crude oil prices have been on the rise because of production cuts by the Organization of the Petroleum Exporting Countries (OPEC). In addition, the low infection rate of Covid and the opening up of the economy have also created a strong demand for crude oil in the economy. 

In its February monetary policy, the RBI said that "the renewed surge in international crude oil prices, however, requires close monitoring. "We need to remain watchful of the risks to domestic inflation arising from the rise in international commodity prices due to exogenous factors, including geo-political developments," it stated.

The government has very limited options. It could either reduce the excise duty or pass on the entire hike to consumers, or do a mix of both to reduce the burden on the end consumers. The government is expected to take a decision after the assembly election results on March 10. 

Currently, oil accounts for more than a fifth of the country's total imports. The only saving grace is the stable value of the domestic currency against the US dollar, despite global turmoil. 

The RBI has enough foreign exchange to protect the value of the rupee, though the risk of dollar outflow still exists.

Globally, inflation fears are already pushing interest rates higher. This week, the US Federal Reserve Chairman Jerome Powell has hinted that the central bank would start raising its short-term rates this month. 

The Bank of England has already hiked interest rates for the first time in more than three years. Similarly, the central banks of Russia, Mexico, and a dozen others have raised their rates.

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