Impact of Crude Oil Price Rise

Why in news?

As a large importer of crude oil, India benefited significantly from lower prices – due to consequent lower inflation & budget deficits.
As oil prices touched a 2 year high this week, some of these gains could be reversed.

What has led to the price rise?

Drawdown in inventories, especially in the US.
Continued geopolitical risk in West Asia (particularly Saudi Arabia).
Better compliance with the voluntary production cut agreed by the ‘Organization of the Petroleum Exporting Countries’ (OPEC)
As the OPEC is expected to work for $70 a barrel, the price spike is expected to stay for a while.

What are the challenges for India?

The Fall years - India witnessed significant positives when oil prices fell by over 50% between 2014 and 2015.
The windfall for the government was to the tune of 0.9% of the GDP in terms of lower subsidy outgo and higher tax collection.
This benefited firms, households and also boosted public investments.
Currently – As oil prices have increased, this could reverse the above and impede economic recovery in the near future.
It could have implications for growth, inflation, currency, current account deficit and fiscal deficit.
Every $10 increase in oil price has been noted to increase CPI inflation by 0.6-0.7% points and also worsen the ‘Current Account Balance’ by 0.4% of the GDP.

What are the actions taken?

Since the government raised excise duty when prices were falling, it could come under pressure to reverse the hike now.
The Union government reduced excise duty by Rs 2 per litre on petrol and diesel last month.
This was followed by a reduction in VAT rates by states such as Gujarat and Maharashtra.
More such moves could strain government finances, lower revenues and would result in lower public investments.
Notably, reduction in excise duty on petrol and diesel by Re1 per litre lowers collection to the tune of 0.08% of the GDP.

What are the macro-economic implications?

The uncertainty in the economy due to oil prices and other factors like GST could worsen the overall outlook in the long run.
If oil prices reach $65 per barrel, inflation could go up by 30 basis points and the real GVA could be 15 basis points lower for the current fiscal.
Inflation fears could potentially prevent rate cuts and weaken market sentiments.
While bond yields have gone up already, persistent higher oil prices will also affect corporate India’s profit margins.
This could delay the much awaited earnings revival and would also affect the equity market where stocks are richly valued.

What is the way forward?

The situation is not alarming for India at the moment, but policymakers would need to be watchful.
While RBI will take a call on interest rates in December, the government needs to avoid the temptation of reducing taxes.
It would need higher revenue to push capital expenditure for fostering economic growth that is currently sluggish.
It will be extremely important to keep fiscal deficit in control in order to protect hard-won macroeconomic stability.

Quick Fact

OPEC (Organisation of Petroleum Exporting Countries)

It is an intergovernmental organization which was founded in 1960 and is headquartered in Vienna.
Its currently has 14 members - “Algeria, Angola, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE and Venezuela”.
OPEC countries account for an estimated 44% of global oil production and 73% of the world's proven oil reserves.
This gives OPEC a major influence on global oil prices and it acts as a cartel of sellers who wish attempt for maximum profits.

Source: Livemint