Exchange Rate Pass-Through to Import Costs

When the rupee depreciates, more rupees are required to purchase one unit of foreign currency. Because petroleum imports are commonly priced and settled in dollars, depreciation raises their rupee-denominated landed cost, a transmission called exchange-rate pass-through.

Transmission to domestic import cost

If a petroleum product costs P dollars and the exchange rate is E rupees per dollar, its basic rupee cost is P multiplied by E. A rise in E, meaning rupee depreciation, increases this cost even when the international dollar price remains unchanged.

• Dollar-denominated freight, insurance and other external charges also become costlier in rupee terms.
• The higher landed cost affects both directly imported petroleum products and refineries using imported crude oil as feedstock.
• Any customs duty or domestic charge calculated as a percentage of value can rise with the higher assessable value.

Why retail prices may not rise proportionately

Pass-through from the exchange rate to the final consumer price can be complete, partial or delayed. The import bill rises first, while subsequent transmission depends on pricing policy and market conditions.

• A fall in the international petroleum price can offset depreciation, while a price increase can reinforce it.
• Existing inventories, long-term contracts and currency hedging can delay the effect.
• Specific taxes and fixed distribution costs reduce the proportional effect of depreciation on the final price.
• Subsidies, regulated prices or absorption by marketing companies can protect consumers temporarily, but shift the burden to firms or the government.

Wider economic effects

Higher petroleum import costs constitute imported inflation because fuel directly affects households and indirectly raises transport, power and production costs. They can also enlarge the merchandise import bill and increase pressure on the current account, especially when import dependence is high.