The Effect of Rising Oil Prices on the Indian Economy

The prices of oil have once again started going through the roof. In the past few years, the prices of oil have seen a steady downturn. This can be largely attributed to the supply gut that was created as a result of a new technology called “fracking.” The world has changed immensely since then. Geopolitical tensions have now created a supply shortage. As a result, the prices of oil are once again on the rise. In this article, we will have a look at some of the geopolitical reasons behind the rise in the price of oil.

Geopolitical Reasons

There has been tremendous instability in many oil-producing nations of the world. Some of the premier examples are as follows:

• Iran is an important supplier of oil for many countries. However, the political relationship between Iran and the United States has deteriorated. This is the reason why America has imposed strict sanctions on Iran. As a result, many nations in the world are now prohibited from buying Iranian oil. The end result is that more than 2 million barrels per day will be removed from the global supply by the end of 2018.
• Venezuela is another very important producer of oil. However, the country is in total political disarray. The economy of the nation is in tatters. They have introduced a new currency to solve the hyperinflation problem. However, the problem has not been solved. Instead, Venezuela now has a major law and order problem in the country. As a result, they are not going to increase the supply of oil.
• Other opportunistic nations like Russia and Saudi Arabia have been reeling with the problem of low oil prices for very long. An increase in oil prices implies a drastic increase in the revenue of these states. Hence, they aren’t likely to increase the supply either

Since none of the major oil producing nations in the world is likely to increase the supply of oil, experts predict that the price may even touch $100 per barrel by 2019. The drop in prices was due to increased supply which resulted from fracking. However, geopolitical tensions have nullified any increase in supply, and the situation seems to be going back to where it started from.

An increase in the price of oil is bad for many economies. For instance, let’s consider the effects on the Indian economy.

High Import Dependence: India is a developing country. As a result, their energy consumption is very high. Also, India does not have its own sources of oil. As a result, it imports more than 80% of its oil requirement. Hence, if the prices of oil double over the period of a year, the import bill of the nation will also double in the same period. India has paid over $110 billion in order to import oil in the year 2017. This figure is likely to double even if the exchange rate is held constant.

Exchange Rate Woes: The Indian rupee has already depreciated against the United States dollar. This is because people are trying to change their rupees for dollars. If the price of oil increases, the government will also be forced to exchange rupees for dollars. Since the import bill is going to be double as compared to last year, it will put tremendous pressure on the rupee. The end result will be a further severe drop in the value of the rupee. The drop in the value of the rupee will force the government to sell even more rupees. This will end up creating a vicious cycle that will bring the economy to a grinding halt.

Hurt the Economy: Many sectors of the Indian economy are dependent on the prices of fossil fuels. For instance, the auto sector is a major contributor to employment in the country. However, since the prices of fuels have risen so much, people are refraining from buying any new cars. This is impacting the profit margins of these companies which is indirectly having a spillover effect on other sectors of the economy as well. Just like automobiles, people have reduced the purchases of generators or any other products which use fossil fuels as inputs.

Discretionary Spending: Higher fuel prices are taking a toll on the Indian consumer. On the one hand, their incomes are not rising because there is a recession in several industries in the market. On the other hand, a rise in fuel prices is eating up a major portion of their income. Rising fuel prices are leading to significant inflation. Hence, their discretionary spending is also being lowered. The end result is the aggravation of the vicious cycle that has already been mentioned above in this article.

Fiscal Deficit

The rise in oil prices is likely to make the situation worse for the government as well. Every $10 increment leads to an increase of about $10 billion in current account deficit. Rising oil prices also reduce the GDP by about 0.5% for every $10 increase. Hence, just like the people, the government is also facing a double whammy.

This is the reason why rising oil prices have been mentioned as one of the main threats to the Indian economy.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.