From UPSC perspective, the following things are important :
Prelims level : NA
Mains level : Rising oil prices and its effects on Economy
- The two major irritants for India this year have been oil and the dollar. The two are a heady cocktail that has distorted all economic forecasts creating volatility that has never been witnessed earlier. Their impact is being felt across bond and stock markets, affecting the entire system. As a result, the RBI and the government have had to work overtime to mitigate the adverse effects on the economy.
What is the current oil prices situation?
- Unpredictable Prices: When the Ukraine war broke out, oil crossed the $120 mark (in April and again in June). It was expected that $150 was not far off. However, the range of $100-110 was restored and soon enough the price was back to the Nineties as all global commodity prices cooled off, even as the Ukraine war continued.
- Rising requirement of Europe: With the winter months approaching and Europe dependent on natural gas for heating, which now appears to be in jeopardy due to Russia turning off the taps, oil has received a boost even though the continent is looking more at coal.
- Reduction in production by OPEC: Add to this the fact that OPEC and its allies have decided to lower production by 2 million barrels a day and there is panic again. This shock is external over which neither the government nor RBI have any control.
- Growing Import Bills: High oil prices mean many things. Crude has a share of 30-33 per cent in total imports and any hike in prices increases the import bill. With exports declining due to the slowdown in global growth and imports increasing due to oil, the trade deficit and current account deficit will widen further. The trade deficit for the first half is $150 billion and can touch $300 billion this year at this strike rate.
- Possibility of Balance of Payment: This creates a problem for the current account deficit with components like software and remittances slowing down due to the recession in the west. Therefore, a balance of payments problem will surface. Ultimately it depends on how high oil will go. The RBI has assumed a $100/barrel. This looks reasonable at this point, but anything higher can create problems on the currency front.
- Increasing Inflation: Inflation per se will be an issue when prices are left to the market like ATF or LPG. But in the case of petrol and diesel, it will be a conundrum for the government. If the status quo prevails on price transmission, then oil marketing companies will have to bear the losses. If the government allows the market to correct, inflation will increase as it will also feed into intermediary costs such as freight.
- Higher input cost: User industries of oil like chemicals, plastics and fertilizers will face a problem again. Higher input costs will put pressure on profit margins and any pass through will be inflationary.
- Windfall tax may increase: The government would probably once again revisit the windfall tax on crude (as has been recently done) to examine if there is any additional revenue to be garnered. Such an environment always tends to spook markets.
- Rising bond yields: Bond yields move up every time oil prices rise while stock markets turn volatile normally in the downward direction.
How rising dollar prices affects India?
- Rupee is weakening: There is the dollar conundrum which should be seen in conjunction with the oil. The dollar has been strengthening against all currencies. As the Fed tightens rates, which will carry on through 2023, the dollar will become stronger. Other countries are already in a weak economic zone and are tightening rates with a lag. The rupee is bearing the brunt of this development. There is no escape as the RBI intervention in any form can only temporarily support the decline in the rupee. In the last month or so, since the rupee crossed the 80 mark and gone past 83.
- Negative sentiment of market: Another factor that will complicate matters is expectations. The recent news, for example, of global players deciding not to include Indian bonds in global indices might add to the negative sentiment in the market and exert pressure on the rupee.
- Imported inflation: The rupee depreciation also leads to importing inflation. All goods imported will come in at a higher rupee cost which will in turn push the RBI to act further.
- Less possibility of high export: The weak rupee may not quite help exports because the competitive advantage that normally comes along with such depreciation would be low given that other currencies are also declining.
- Trade deficit will rise: Imports are unlikely to slow down as a growing economy requires inputs and raw materials. This will mean further pressure on the trade deficit. The government will gain at the margin as customs collections increase.
- Volatile investors: The critical reaction will be that of investors. If foreign portfolio investors withdraw then there will be further pressure on the rupee while inflows would help to cushion the rupee.
- Centre may lose on revenue: State governments will be better off as their VAT collections would increase automatically. However, the Centre may not gain as the excise duty is a fixed rate.
- One can never tell as almost all forecasters have been proved wrong this year. The theory that RBI can intervene and protect certain levels of currency has its limitations. These travails have to be responded to as they cannot be controlled.
Q. How rising dollar and oil prices affects the macroeconomic stability in India? What are the steps taken by RBI and GOI to manage the macroeconomic stability?