Impact of Oil Price Rise

What is the issue?

The rising oil price trend is likely to have repercussions on the overall economy, which calls for concerted government actions.

How has oil price been?

• Brent crude oil is the international benchmark price for oil.
• Brent crude was ruling near $120 per barrel in the mid-2014.
• The prices fell to a low point of $29 in January 2016, before climbing back up.
• A year ago, the price had crossed $50, and by December was over $60.
• In May, 2018 it crossed $70, and is now past $80.
• It is highly expected to cross $100 once the U.S. sanctions on Iran kick in, and reach as high as $120 in 2019.

How have past oil price shocks been?

• Oil price shocks in the past have mostly derailed the Indian economy, usually in conjunction with other factors.
• It happened in 1973-74, when the international crude oil price doubled in a year of poor harvests.
• India’s inflation rate rose sharply as growth tumbled.
• The second oil shock, of 1979-80, saw oil at $111, which along with another bad harvest caused GDP to shrink by a high 5%.
• The third was during the first Iraq war when average price for 1990 was only $43.
• But it tipped the country into the foreign exchange crisis of 1990-91.
• The oil shock of 2008 (average price of $104) came with the financial crisis of the same year, the combined effect causing a sharp dip in GDP growth.
• Oil prices stayed high through 2011-14, at over $90, causing the country’s current account gap to leap to 4.8% of GDP in 2012-13.
• Also, growth plunged to the lowest levels in a decade, and the rupee crashed down.

What could now be the implications?

• Along with oil price rise, the rupee has fallen against the dollar in the interim, and taxes increased.
• The petrol and even diesel prices could thus likely be headed for the three-figure mark.
• If the prices keep increasing as predicted, India will be back where it was years back.
• The trade gap, inflation, rupee’s external value and economic growth could all come under pressure.
• The current account deficit, already projected in danger zone at close to 3% of GDP, could further worsen and make rupee the same.

What is the way ahead?

• If the government eases consumer pressure by lowering taxes on petroleum products, revenue loss will affect fiscal numbers.
• If inflation climbs and RBI sticks to its inflation target, higher interest rates will constrict both investment and consumption, affecting growth.
• Keeping Iranian oil exports going will moderate price spikes, and therefore the size of the oil shock.
• So the policy choice is whether to continue buying oil from Iran as it is the Iran sanctions that are expected to send oil prices higher.
• But the challenge is that it could invite US sanctions.

Source: Business Standard