AN ARTICLE ON: “IMPACT OF RISE IN CRUDE OIL PRICES ON THE INDIAN ECONOMY” SUBMITTED BY: AMITKUMAR RAJANI Master of Management Studies (MMS 2010-12)Prin. L.N. Welingkar Institute of Management Development & Research, Matunga MOBILE: 9881273855 E-MAIL: firstname.lastname@example.org
"IMPACT OF RISE IN CRUDE OIL PRICES ON THE INDIAN ECONOMY” INDIA’S CRUDE OIL REQUIREMENTS India needs to sustain an 8% to 10% economic growth rate, over the next 25 years, if it is to eradicate poverty and meet its human development goals. With high economic growth rates and over 15 percent of the world’s population, India is a significant consumer of energy resources. DespiteCRUDE OIL PRICE TRENDS 2000-2010 (US$ Per Barrel) 2010 the global financial crisis, India’s energy demand continues to rise. But India faces formidable challenges in meeting its energy needs ing and in providing adequate energy of desired quality in various forms in a sustainable manner and at competitive prices. Oil meets about 24% of India’s commercial energy requirements . In 2009, India with a consumption of 3 million barrels per day was the 4th rels largest oil consumer in the world after the United States, China, and Japan . SOURCE: National Energy Board, Canada India’s proven reserves of crude oil roven and oil production have not witnessed INDIA’S CRUDE OIL IMPORTS (in Rs. Crores) any significant improvement in the last few decades. As a result, India . 400,000 348,288 largely relies on imported crude oil to gely 350,000 meet its energy requirements. requirements 300,000 In 2009, India was the 6th largest 219,029 net importer of oil in the world, 250,000 272,699 importing nearly 2.1 million barrels per b 200,000 248,226 day, or about 70 %, of its oil needs as , 150,000 117,003 171,702 compared with 44 % in 1995 . 100,000 Nearly 70 % of India’s crude oil 50,000 83,528 imports come from the Middle East, 0 primarily from Saudi Arabia, followed 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10* 07 by Iran . SOURCE: Annual Report 2009-10, Ministry Of Petroleum & Gas 10, *: Up to December 2009
IMPACT OF RISE IN CRUDE OIL PRICES ON The Energy Information Administration (EIA) INDIA’S GDP GROWTH (% Change)expects India to become the 4th largest netimporter of oil in the world by 2025, behind theUnited States, China, and Japan. OIL UNDER RECOVERIES The dependence on crude oil imports ischronic for a developing country like India asIndias current resource utilisation pattern doesnot contain alternatives to imported crude.Furthermore, in a situation of unabated rise in SOURCE: FICCIoil prices the problem tends to getcompounded. ECONOMIC IMPACT OF RISE IN OIL PRICES Government Owned Oil Marketing India’s huge dependence on Imported CrudeCompanies (OMCs) in India sell petroleum Oil makes it vulnerable to the shocks &products (excluding Petrol) at a subsidized rate. disruptions in the Global Oil Market.The losses incurred by these companies are But the overall impact of the high oil pricescalled “Under Recoveries”. The Government of on the Indian economy is restrained by factorsIndia compensates the OMCs for these under like the comfortable balance of paymentrecoveries either through cash payment or issue position, the large foreign exchange reservesof bonds. and the access to international capital. These Under recoveries of OMCs for the FY 2008-09 parameters have improved substantially inwere Rs. 1,03,292 Crores. The Government India’s favor as compared to the previousissued oil bonds to the tune of Rs. 71,292 Crores period of high oil prices.whereas the remaining burden of Rs. 32,000 However, any sharp spike in oil prices in theCrores was shared by Upstream Oil Companies. global market results in an unfavorable Even after compensation by the government economic situation. The reasons for the same& Upstream Oil Companies, the combined net are outlined below.profit of IOC, BPCL and HPCL during FY 2004-05 a) RISE IN COST OF IMPORTS: The first victimto FY 2008-09 declined by 60 % . of rise in crude oil prices is the state As the authorized private sector OMCs, viz. exchequer. Every increase of $1 per barrel inReliance Industries, Essar Oil and Shell India Indian crude basket prices pushes up thewere not part of the above subsidy sharing annual oil import bill by $1.2 billion . It alsoarrangement they closed down their retail leads to a faster depletion of India’s Foreignmarketing business across the country. Exchange (FOREX) Reserves. Fixation of prices of these essential b) WIDENING OF TRADE DEFICIT: India’s tradecommodities by the Government at different deficit for 2009-10 was $117.3 billion . Thepoints of time leads to speculations, hoarding, steep increase in imports due to high oiltemporary shortages and above all diversion of prices leads to a further widening of theDiesel, LPG, and Kerosene to unintended uses. trade deficit.
c) INCREASE IN OIL U NDER RECOVERIES: As the IMPACT OF HIKE IN FUEL PRICES IN THEpricing of Diesel, LPG & Kerosene is still DOMESTIC MARKETunder government control, any rise in A sustained rise in international crude oilinternational oil prices is not reflected in the prices leads to bleeding of the state exchequer.domestic market. The inability of OMCs to It becomes untenable for the government tosell fuel at the market defined rate results in allow the subsidy bill to inflate in times of globalhigher under recoveries. supply shocks & disruptions. In such cases, thed) MOUNTING FUEL SUBSIDY BURDEN: Any government passes on the burden to thehike in price of imported crude oil is consumers by allowing the OMCs to hike theabsorbed by the OMCs along with the fuel prices in the domestic market. The hike inUpstream Oil Companies & the federal fuel prices has a cascading effect on the Indiangovernment. The fuel subsidy bill has Economy. The same is explained below.witnessed a continuous rise for the past few a) INFLATION: Rise in fuel prices has a directyears. From FY 2005-06 to FY 2008-09, impact on the prevailing inflation rate inGovernment’s fuel subsidy bill amounts to the economy. Higher fuel prices (inRs. 1,42,203 Crores . particular Diesel) lead to increase ine) WORSENING FISCAL DEFICIT : India’s Fiscal transportation costs across the country.Deficit for 2009-10 stood at 6.6 % of Gross As a result of which the price of essentialDomestic Product (GDP) . Rise in crude oil commodities (such as food items,prices worsens the situation as Government cement, coal etc) shoots up. Inflationaryhas to shell out more money in the form of expectations among traders lead tofuel subsidy to OMCs. hoarding which pushes the spiralingf) REDUCED AMOUNT FOR INFRASTRUCTURE inflation rate further up.INVESTMENT: India aims to invest $1 Trillion in b) EROSION O F PROFIT MARGINS: Rise ininfrastructure development during the 12th inflation rate in turn leads to erosion ofFive Year Plan (2012-17) . High prices of profit margins of business enterprises ascrude oil (leading to higher fuel subsidy & the key inputs for business becomeincrease in fiscal deficit) have the potential costlier & consumers reduce theirto derail the government’s plans as they eat spending. Inevitably, the earnings growthinto the amount of disbursal available with of corporate India slows down.the government for infrastructure & social c) HIKE IN INTEREST RATES: The Reservedevelopment schemes. Bank of India (RBI) is entrusted with the responsibility of containing inflation in A continuous rise in the subsidy bill & the Indian economy through periodicworsening fiscal deficit has forced the Monetary Policy review. In case offederal government to deregulate the petrol inflation zooming beyond the comfortprices in the domestic market while in- zone, the RBI steps in to bring it down toprinciple approval has been given for an acceptable level. It does so byderegulation of diesel prices. However, the increasing the Cash Reserve Ratio (aGovernment reserves the right to intervene portion of deposits which banks have towhenever the situation demands. keep with the RBI), Repo Rate (the rate
at which banks borrow funds from the IMPACT ON KEY SECTORS RBI) & Reverse Repo Rate (the rate at The performance of business enterprises which RBI borrows money from the across the country is affected due to banks). As a consequence of rise in these increase in fuel prices in the domestic key rates, banks are left with lesser economy. But some sectors suffer a greater funds to lend to their customers. loss as compared to the others. They include Thereby sucking out the excess liquidity the Automobile Industry (dearer personal in the economy. Banks are forced to loans leading to fall in sales), FMCG Sector follow suit & increase the cost of loans (erosion of profit margins due to rise in cost to its customers. A hike in interest rates of raw materials), Banking Industry (slow also attracts foreign capital flows which down in credit growth), Civil Aviation may lead to appreciation of the Indian Industry (rise in price of Aviation Turbine Rupee. Such appreciation dampens the Fuel), Oil Refining Industry (higher under profitability of Indian exporters, at times recoveries), Paint Industry (crude oil is a forcing them to shut shop. major input for solvent based paints) andd) CAPEX POSTPONEMENT: Corporate India many others. Incidentally, the above largely relies on borrowings from banks mentioned sectors also figure in the list of for business expansion. In view of sectors which provide high direct & indirect inflationary trends & dearer cost of employment opportunities. funds, corporate India puts it Capital Expenditure (CAPEX) plans in the cold NEED FOR REFORMS storage. The idea is to wait for the It is imperative that the Indian inflation & interest rates to come down government brings about the necessary before initiating any new projects. reforms to strengthen the domestic oile) REDUCTION IN CREDIT GROWTH: A reduced market. level of investment in the economy due The key reforms include: (1) Rational to increase in interest rates leads to a pricing of petroleum products, (2) Reducing slowdown in the credit growth (Loan taxation on petroleum products & tapping Disbursement) of banks, the lubricant of alternative sources of revenue to every economy. compensate the loss due to reducedf) FALL IN EMPLOYMENT OPPORTUNITIES: As taxation & (3) Removal of entry barriers for business activity in the economy takes a private players in distribution and retail hit, generation of employment business in order to create real market opportunity also suffers a setback. competition.g) SLOWDOWN IN ECONOMIC GROWTH: A sustained rise in interest rates in the As the Indian Economy treads the path of economy begins to hurt the economic growth, its appetite for crude oil as a crucial growth. Reduced investment, lower source of energy will only increase. Given spending on infrastructure & fall in India’s chronic dependence on imported domestic consumption of goods & crude oil, the Indian Economy’s fuel import services puts a break on the growth of bill will continue to remain vulnerable & the economy. sensitive to fluctuations in world oil prices.
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