International oil prices and its impact on Indian economy

Abstract

Historically crude oil price behave much as any other commodity but many times an extreme price swings have been witnessed which is mostly driven by a supply demand mismatch in international crude oil market. Prices of oil and some base metals have dropped considerably in the second half of 2008, following the deepening of the international financial turmoil, and expectations of a global slowdown. However, with supply expected to remain limited by disruptions in producing areas, weak non-OPEC supply and the slow development of alternative fuels, the projected increase in world crude oil demand by emerging markets of 3 ¾ percent a year during 2008-2012(1)is most likely to spur further generalized bouts of CPI inflation from ensuing increases in the price of oil and food in the years to com. Volatility of crude oil prices have increased in current geo-political scenario. Supply management policies of OPEC and unstable political situation in many of the oil importing nations have always resulted in wide fluctuations. The major shocks in international crude oil prices in past 50 years could be seen in Figure 1 below. Huge volumes of speculative trades on derivative have also been blamed by some politicians for these extreme fluctuations. Although no clear evidence has emerged whether extreme volatility has been caused by the above factors or volatility happens in case of supply-demand mismatch. While this volatility and rapid rise in price affected the financial planners of oil importing nations in 1sthalf of 2008, its rapid fall has affected economies of oil producing nations. Consequently demand of other goods has been impacted globally and economies of many exporting nations are facing a crisis. Like any other globalized economy of today’s world, oil prices and inflation were also two of the biggest worries for Indian stock market in 1sthalf of year 2008. Task of managing economy becomes even more difficult when finance ministers have to allocate subsidy for one of the widely used commodity products like oil. Any effort on controlling fiscal & revenue deficit is unlikely to give concrete results if oil subsidy remains as high as seen in 2007-08in India. The country paid $8.7 billion in oil subsidies in 2007 or 0.7 per cent of the GDP. On the other hand, government could boost infrastructure when oil prices are not required to be subsidized by utilizing the funds which are currently being drained in oil subsidy. In this study, we have attempted to study few aspects of impact of international crude oil prices on India economy. The report first summarizes the theoretical aspects of the relation with crude oil prices and would later delve into the specific aspects which are considered in greater depth in a subject which has many inter-twined pieces.