[op-ed snap] The impact of rising oil prices on Indian economy

Note4students

Mains Paper 3: Economy | Indian Economy

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Impact of rising crude oil prices on CAD, fiscal deficit, etc.


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India was a key beneficiary of falling crude oil prices between 2013 and 2015

  1. Some research had indicated that almost the entire reduction of about 0.6% of the GDP in India’s fiscal deficit between FY14 and FY16 could be attributed to the sharp fall in crude prices
  2. Lower crude prices also contributed to the narrower current account deficit
  3. But the pass-through of the fall in crude prices to retail consumers was limited
    (the government retained a large part of the benefits by hiking excise duty on retail fuel products)

Risk of rising crude prices

  1. With the US’ decision to walk away from the Iran nuclear deal and to re-impose sanctions on Iran, upside risks to crude prices cannot be ruled out

Possible impact of higher crude prices on the Indian economy

  1. We can conclude that higher crude prices will adversely affect the twin deficits of the economy(fiscal and current account deficit)
  2. It will also have impact on the monetary policy, and consumption and investment behaviour in the economy

Possible reasons behind this increase

  1. According to the recent World Economic Outlook (WEO) by the IMF, roughly 80% of the recent oil price increase was caused by deterioration in supply conditions
  2. This, however, is not the only study on the factors leading to higher crude prices
  3. The “Oil Price Dynamics” report published by the Federal Reserve Bank of New York finds that less than two-fifth of the rise in oil prices since the beginning of 2018 was on account of supply-side factors
  4. These contrasting studies lead to uncertainty regarding the sustainability of higher crude prices

Data on fiscal conditions

  1. An increase of $10 per barrel in crude prices will lead to an increase of about Rs17,000 crore (or $2.5 billion at an exchange rate of 67/$) in fuel subsidies, equivalent to 0.09% of GDP
  2. In the Union Budget 2018-19, the government had budgeted for petroleum subsidy of Rs25,000 crore, similar to that in FY18

Impact on Current Account of deficit

  1. An increase of $10 per barrel in crude oil prices will lead to an adverse impact of $10-11 billion (or 0.4% of GDP) on current account deficit
  2. There are two opposite forces at work in current account deficit. Higher oil prices will push the import bill higher;
  3. however, it will be partly offset by higher oil exports and better remittances

Possible impact on inflation

  1. With a weightage of only 2.4% in headline CPI, the adverse impact will entirely depend on the extent to which higher crude oil prices are passed on to the consumers
  2. Considering the general election next year
  3. and thus, the direct impact on CPI inflation is likely to remain muted