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Stock markets: Crude concerns

Aug 24, 2000

Crude prices have crossed the US$ 32 per barrel mark, 255% over the lows recorded in early 1999. The governmentís options are limited to hiking prices. The question is when and by how much. A hike in fuel costs would definitely delay the recovery in atleast the transportation sector. Commercial vehicle manufacturers, which had earlier in the year projected a robust volume growth of 20%, have already had to moderate their projections due to effects of the drought. A hike in fuel costs will further suppress demand, as sluggish freight rates may make it difficult for operators to pass on the rise in diesel costs. The transportation sector is only one of the many sectors that will be adversely affected.

A rise in fuel costs will permeate economy wide, as the cost of transportation and diesel power generation (among other cost push effects) will rise. Consumers will have to cut back on spending, as fuel bills will rise. This will result in an increase in the overall price levels. A higher inflation rate could in turn have implications for the exchange rate and the monetary policy.

The government on the other hand is faced with limited options. The subsidy bill is rising, although it is off-budget. Nevertheless the shortfall is to be met. The petroleum minister has stated that one option is to reduce the customs duty on crude, in effect transferring money from the budget account to the oil pool account. Well that sounds fine, if the government were to clarify on how it plans to then meet the deficit in the budget account.

The government needs to increase the prices of fuel. Okay, a part of it can be transferred from the budget account (by reducing the customs duty), but this is not a permanent solution. What if crude oil prices continue to rise? Customs duty cannot be reduced every time crude prices rise (It canít go below zero!).

The stock markets have probably factored in a fuel hike, and this is evident from the valuations accorded to commercial vehicle manufacturers. Sectors such as cement, which spend a large part of their operating costs on transportation and power, too have seen their valuations declining in recent months.

The stock markets have taken note of the situation. Itís high time the government tread the same path.

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