RISE IN OIL PRICE AND ITS IMPACTS – ECONOMY

●       Crude oil prices had been firming up for the past few weeks on expectations of high demand and tightening supply, reaching a nearly 10-month high.

●       The global benchmark Brent crude breached the $90-per-barrel mark for the first time in 2023 and continued to hover around that level.

Reasons for Crude Oil Price Rise:

1. Major oil-producing countries, particularly those in the OPEC+ group, have played a pivotal role in influencing oil prices through production cuts.

2. The recovery of the global economy from the COVID-19 pandemic has led to increased demand for oil.

3. Geopolitical tensions in oil-producing regions, such as the Middle East, can disrupt the supply of oil.

 

Impact on the Global Economy:

Inflationary Pressure:

1. Cost of Production - Many industries and businesses rely on oil for their operations. When oil prices rise, it increases the cost of production. Companies may pass these increased costs onto consumers in the form of higher prices for goods and services.

2. Transportation Costs - High oil prices lead to more expensive transportation, affecting the prices of goods that are transported by road, air, sea, or rail. This transportation cost increase can ripple through the supply chain, ultimately affecting consumer prices.

3. Consumer Impact - As consumer prices rise, people's purchasing power may be reduced, leading to decreased consumer spending. This, in turn, can impact economic growth.

 

Economic Growth:

1. Reduced Consumer Spending - When consumers face higher prices for goods and services, they may reduce their spending in other areas. This can lead to slower economic growth, as consumer spending is a significant driver of economic activity.

2. Business Costs - Businesses that rely heavily on oil-based inputs may experience reduced profit margins due to increased production costs. This can lead to decreased business investment and hiring, affecting overall economic growth.

3. Consumer Confidence - High oil prices can erode consumer confidence in the economy, leading to cautious spending behaviour.

 

Trade Imbalances:

1. Countries that are heavily reliant on oil imports can indeed face trade imbalances and pressure on their foreign exchange reserves,

2. Trade Deficits - High oil prices can increase a country's trade deficit, as it spends more on oil imports than it earns from its exports. This can strain the country's balance of payments.

 

3. Currency Depreciation - The trade imbalance caused by high oil prices can lead to currency depreciation. A weaker currency can further exacerbate the trade imbalance and reduce the purchasing power of the country's currency on international markets.

4. Foreign Exchange Reserves - Maintaining adequate foreign exchange reserves becomes crucial for countries facing trade imbalances. These reserves are needed to stabilize the currency and ensure international payment obligations can be met.

 

Impact on India:

India is particularly vulnerable to rising oil prices due to its high import dependency on oil. The impact of rising oil prices on India is indeed significant, given the country's high import dependency on oil (around 80% crude oil is being imported in India)

 

Inflation:

1. High oil prices contribute to inflationary pressures in India. When oil prices rise, it affects the cost of transportation, which, in turn, impacts the prices of goods and services.

2. Inflation erodes the purchasing power of consumers, making it more expensive for people to meet their daily needs. This can lead to reduced living standards for citizens.

 

Trade Balance:

1. India imports a substantial portion of its oil to meet its domestic demand. When oil prices increase, the cost of these imports rises.

2. Higher oil import costs can lead to a widening trade deficit, as the value of imports exceeds the value of exports. This imbalance puts pressure on the country's trade balance.

 

Current Account Deficit:

1. The current account includes the balance of trade in goods and services, as well as investment income and transfers. A rising trade deficit due to higher oil import costs can contribute to a current account deficit.

2. A current account deficit indicates that India is spending more on imports and external obligations than it is earning from exports and investments.

 

Currency Depreciation:

1. To pay for rising oil imports and cover current account deficits, India may need to spend more foreign exchange reserves. This can put downward pressure on the value of the Indian rupee.

2. A depreciating currency can lead to higher import costs for a wide range of goods, beyond just oil, and can negatively affect India's purchasing power abroad.

 

Economic Growth:

1. Elevated oil prices can increase input costs for businesses across various sectors, from manufacturing to transportation.

2. When businesses face higher costs, they may reduce production or pass these costs on to consumers, potentially hampering economic growth.

 

WAY FORWARD:

●       Transition to electric vehicles.

●       Improved fuel efficiency and combustion efficiency.

●       Hydrogen fuel based transportation e.g Hydrogen fuel cell.

●       Ethanol blending program e.g. as of now 10% blending aimed to attain 20% blending.

●       Strategic petroleum reserves in India.

These steps collectively aim to enhance India's energy security, reduce its vulnerability to oil price volatility, and support its transition toward cleaner and more sustainable energy sources.