Why a drastic fuel price hike is dangerous
Drastically increasing fuel prices can lead to mounting inflation, which can thwart economic growth and threaten food security
Bangladesh Petroleum Corporation (BPC), the state-owned corporation responsible for procurement of petroleum in Bangladesh, has hiked prices of fuel by 47% on average at a time when the WTI crude oil prices in the international market have fallen 32%, from highs in March of $129 to pre-Ukraine war levels of $88 per barrel.
The corporation has hiked the per litre price of kerosene by 43% to Tk114, octane by 52% to Tk135, petrol by 51% to Tk130 per litre and diesel by 43% to Tk114.
Overall, the average hike is around 47%, which is unprecedented given that these four types of fuel are the most commonly used in Bangladesh.
In FY21, in total, kerosene, octane, petrol and diesel all accounted for 84% of total fuel consumption. Of this, diesel alone accounted for 73% of total fuel consumption, making it the most commonly used fuel in the country.
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Agriculture accounted for 15% of fuel consumption, while communication (transport) accounted for 65% of fuel consumption. In total, 78% of fuel was consumed by communication and agriculture in FY21.
These two sectors also represent a large weight in the CPI basket, using which inflation is calculated. According to CPI basket weights, on a national level, rice accounts for 19.6% of the CPI basket, while transport and communication accounts for 7.9%.
On average, diesel costs account for 33% of total cost of production of rice. This means a hike in rice prices alone can lead to inflation rising by 3%.
Similarly, transportation, which is also heavily reliant on diesel, may directly add 2% to inflation.
Inflation during July 2022 was 7.48%. This means a 5% direct increment attributing from hiked transport costs and rice only will result in 12.48% inflation.
However, we must keep in mind that these were merely the direct impact of the hike. Taking other indirect impacts caused by a spillover effect will further aggravate the inflationary situation.
For instance, while the production of protein-based food and vegetables may not be fuel intensive, its distribution is fuel intensive.
Given food accounts for 54% of the CPI basket, even a minor hike in logistics cost can be catastrophic for the economy.
On one hand, it is understandable that the government's hands are tied – given that foreign currency reserves are depleting, local currency is losing value while oil prices are still high under pressure.
On the other hand, the government must rethink its decision to hike fuel prices so drastically and if required, hike rates in multiple stages.
This is critical because, in the recent past, countries that have hiked fuel prices drastically were met with mounting inflation, which thwarted economic growth and threatened food security, since fuel is an essential item and its demand hence greatly inelastic in nature.
For instance, peer countries like Pakistan and Sri Lanka, who have increased diesel prices by 64% and 49% in the past three months have inflation numbers as high as 25% and 61% respectively.
Countries that have marginally, or not increased diesel prices have single digit inflation numbers, indicating that slower and incremental rate hikes are far less detrimental compared to sudden hikes.
