Oil price shock for economy

Sushma Ramachandran

The clouds on the horizon have finally turned into a perfect storm. World oil prices, rising gradually over the past year, have reached the heights of $ 75 per barrel of the benchmark Brent crude.  India, as the world's third largest oil importer, will have to face major challenges regarding the impact on economic growth. Till a few months ago, enhanced shale oil output in the U.S. was expected to keep demand under control by the summer. But this expectation has been belied and prices are now at their highest since the past four years. India like many other emerging economies will find it hard to deal with the repercussions.

The reasons for hardening global oil prices are many but the most important has been the decision of oil exporting countries cartel, OPEC, to ensure that members adhere to production quotas laid down since November 2016. In addition, Russia, the world's largest oil producer has been cooperating with OPEC to curtail output. Political turmoil in some countries like Venezuela and Libya had also affected the level of oil availability in the market. In the meantime, demand in major importers like China has been rising as its economy is coming back to an even keel. The situation is not likely to ease soon as the U.S. government has decided to revoke its nuclear deal with Iran. This in turn means that the sanctions on that country may come back into force. These include curbs on production and sale of oil by Iran. It may also impact Iraq's oil output as the two countries' oil quotas have been linked in the past. In other words, oil availability in the coming months is likely to decline even further, fuelling a fresh round of rising prices.

The impact is already being felt by consumers here as diesel and petrol prices have reached the highest levels since 2014. This is bound to have an inflationary impact on the economy. In addition, the higher cost of oil imports will lead to a widening of the trade deficit and the current account deficit which is already at 1.9 per cent of GDP during the April-December 2017 period. The cost for India which imports 80 per cent of its oil consumption has increased from $ 71 billion in 2016- 2017 to nearly $ 88 billion in 2017-18. The recent rapid depreciation of the rupee will only add to the burden on the exchequer in the current fiscal. 

Currently domestic petrol and diesel prices are linked to international markets and hence rates have been raised over the past few months. But the government seems to have frozen this pass- through for several weeks till the polling to Karnataka assembly elections was over. This should mean pressure on the public sector oil marketing companies which will have to absorb the losses. It could mean a return to the era of the UPA government when oil companies were saddled with huge under -recoveries from petroleum sales.

One solution to the oil crisis is obviously is to cut taxes on petroleum products. These are already at unreasonably high levels as the government had taken advantage of the low import prices at the beginning of its tenure to hike excise duties. It has made some reductions since then but will not want to make more cuts right now as these will affect central government revenue inflows. Ideally petroleum should be brought under GST but states have been resisting any such move. They are equally worried about the prospect of losing their revenues from this particular cash cow. The loser is, as always, the consumer who ends up paying inordinately high taxes on oil products. 

Unless a way is found to mitigate the oil price shock, the pace of economic growth is bound to be affected by this external factor.  It will mean a big setback as the economy is only now limping back after the twin setbacks of demonestisation and the launch of GST. Economic growth has till now been expected to rise at around 7.4 per cent in the current fiscal, but soaring oil prices mean a likely slowing of this pace.

Though there are limited options to deal with the problem in the short run, some are finally being explored in the international arena. This includes India trying to tie up with other large importers like China to get a better deal from exporting countries. There is now even talk of a consumers' collective being proposed to include major buyers like China, Japan, South Korea and India. This could be a game-changer as China and India are the second and third largest importers of oil. A cheaper price for the major buyers needs to be aggressively negotiated as well as doing away with the higher rates for Asian countries, euphemistically termed the "Asian premium". Long term purchase agreements could be tied up with oil suppliers at more competitive rates to the benefit of importing countries.

Ironically this was the same problem facing the UPA government at the end of its tenure. At the time, when then Prime Minister Manmohan Singh referred to the external factors that had impeded growth during his last term, it was dismissed by the newly anointed government as excuses for non-performance. Oil prices had then even touched heights of 140 dollars per barrel at one stage. While the market has not yet firmed up to this extent, the prediction for global prices by the end of the year is pegged at 90 dollars per barrels. Ultimately,  the NDA government may find itself in the same position of having to blame external factors for slow growth at the end of its tenure. 

The fact is, the situation is beyond any government's control in the short run. In the long run, energy security needs to be given much higher priority than it has been in the past. The role of renewable energy, nuclear power and natural gas needs to be expanded as has been repeatedly pointed out in these columns. Otherwise the economy will continue to face roadblocks due to excess reliance on petroleum as the predominant energy source for all sectors.