The energy headwind

News: The rise in prices of energy may slow down the economic recovery and growth rate.

How are energy prices linked to economic recovery and growth?

Economic Productivity is directly related to the use of dense forms of energy*. Improvements in Indian economy’s energy density means India’s energy demand grew 2.5% slower than India’s GDP growth. But lack of reserves of dense fuels (oil, gas etc.) means India’s energy imports are growing faster than the GDP.

Energy imports accounted for nearly 80% of India’s trade deficit in 2019-20. The rapid rise in energy prices globally has bloated India’s energy import bill. While some deficit can be covered by exports; the shortfall is covered through fund inflows (sale of equities) or through loans. This additional payout to foreign suppliers limits demand for domestic products.

Household consume almost 40% of the crude oil products directly, while 60% are used by Industry. Industry will pass on the price rise to consumers eventually which will reduce the demand and slow the growth.

What were the reasons for cut-down on excise duty on fuels?

The cut-down announced by the Government on excise duties will reduce cost to consumers by $20 billion. The Government has surplus receipts due to high fuel prices and consequently higher revenue from duties. The Union Government has already received 56% of budgeted receipts in the first 6 months (April-September) compared to the norm of 40%. Thus, the reduction in duties made sense.

Another reason was inflationary pressure of high fuel prices. The fuel price cut will reduce the CPI by at least 30 basis points.

What is the outlook for the future?

Rise in prices of Coal has been short-lived as production of coal has ramped-up in China. Inventories are also better in Indian thermal plants. This showed that there are no structural issues in the energy supply chain, only that production had gone down during the pandemic phase due to low demand. Rising demand is now a signal for fast economic recovery.

Now the focus of the policymakers should be on sustaining this recovery and focus on the priorities of next phase of economic cycle.

For Indian economy to grow at 7%, energy demand would grow by 4-5% annually. India’s energy security and insulating the economy from external energy price shocks should be the top-most policy priority. Moreover, with new emission targets, India’s energy mix should be at the center of energy policy.

* Energy density means energy stored per unit mass or volume, higher the energy density, higher the energy, and better the fuel, e.g., Energy density of Natural Gas is 55MJ/kg while Wood has 16MJ/kg, Gas is much better fuel than wood)

Source: This post is based on the article “The energy headwind” published in Times of India on 9th November 2021.