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Why is sharp fuel price hike dangerous?

Fuel prices can lead to sharply rising inflation, which can hinder economic growth and threaten food security

06 August, 2022, 08:10 pm

Last modified: 06 August, 2022, 08:17 pm

The number of intra-city buses in the capital has reduced significantly since Saturday morning following the government’s move to increase fuel prices. Photo shows the empty Farmgate, one of the busiest Dhaka intersections, taken on Saturday, August 6, 2022. Photo: Rajib Dhar/TBS

“> The number of intra-city buses in the capital has reduced significantly since Saturday morning following the government's move to increase fuel prices.  Photo shows the empty Farmgate, one of the busiest Dhaka intersections, taken on Saturday, August 6, 2022. Photo: Rajib Dhar/TBS

The number of intra-city buses in the capital has reduced significantly since Saturday morning following the government’s move to increase fuel prices. Photo shows the empty Farmgate, one of the busiest Dhaka intersections, taken on Saturday, August 6, 2022. Photo: Rajib Dhar/TBS

Bangladesh Petroleum Corporation (BPC), the state-owned corporation responsible for petroleum procurement in Bangladesh, has raised fuel prices by an average of 47% at a time when WTI crude oil prices in the international market have fallen 32% from their peak. $88 per barrel to East Ukraine war levels from $129 in March.

The corporation increased the price of kerosene per liter by 43% to Tk114, octane by 52% to Tk135, petrol by 51% to Tk130 and diesel by 43% to Tk114.

Overall, the average increase is about 47%, which is unprecedented for these four types of fuel commonly used in Bangladesh.

In FY21, collectively, kerosene, octane, petrol and diesel accounted for 84% of total fuel consumption. Of this, diesel alone accounts for 73% of the total fuel consumption, the most commonly used fuel in the country.

Agriculture accounts for 15% of energy consumption, while communication (transport) accounts for 65% of energy consumption. Overall, 78% of energy was consumed by communication and agriculture in FY21.

These two sectors represent the largest weights in the CPI basket, using which inflation is calculated. In terms of CPI basket weight, at the national level, rice accounts for 19.6% of the CPI basket, while transport and communication accounts for 7.9%.

On average, diesel cost accounts for 33% of the total production cost of rice. This means that an increase in the price of rice can lead to a rise in inflation by 3%.

Similarly, transport that relies heavily on diesel can directly add 2% to inflation.

Inflation in July 2022 was 7.48%. This means that a direct increase of 5% would result in an inflation of 12.48% due to increased transport costs and rice alone.

However, we must remember that these are only the direct effect of the increase. Taking other indirect effects caused by the spill over effect further exacerbates the inflationary situation.

For example, while the production of protein-based food and vegetables is not energy intensive, its distribution is energy intensive.

Given that food accounts for 54% of the CPI basket, even a small increase in logistics costs can be catastrophic for the economy.

On the one hand, the government’s hands are understandably tied given that foreign currency reserves are depleting, the local currency is depreciating while oil prices remain under high pressure.

On the other hand, the government should reconsider the decision to drastically increase fuel prices and, if necessary, increase the rates in multiple steps.

This is critical because in recent times, countries that have sharply increased energy prices have faced rising inflation, which has hampered economic growth and threatened food security, as energy is an essential commodity and its demand is highly volatile in nature.

For example, peer countries like Pakistan and Sri Lanka, which have increased diesel prices by 64% and 49% in the last three months, have inflation rates of 25% and 61% respectively.

Countries that have seen little or no increase in diesel prices have single-digit inflation numbers, indicating that slow and incremental rate hikes are far less harmful than sudden hikes.

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