How the oil crisis affects India’s economy

Mangalore Today / yahoomail

Natalia George,  Yahoomail

Thursday 14 April 2011: India’s growth prospect largely hangs on where the oil prices are headed say most analysts. Why do oil prices play such a vital role on the future of the world’s second fastest growing economy?

India ranks among the top 10 largest oil- consuming countries and oil accounts for about 30% of India’s total energy consumption.

Now India imports about 70% of its total oil consumption and makes no exports. This naturally would create a supply deficit, as domestic oil production is unlikely to keep pace with demand. India’s rough production is only 0.8 million barrels per day.

 

An IMF report says that among the oil importing countries, the largest impact on GDP growth and the balance of payments is expected to be felt in India, Korea, Pakistan, Philippines, Thailand, and Turkey.

The report further indicates that a USD 5 per barrel increase in oil price would lead to a 1.3% increase in inflation and a drop of 1% in GDP growth.

Skewed Balance of Payments due to oil imports

Although the entire burden of the spike in price has not been passed to the domestic consumer, the Indian government’s finances have taken a sufficient hit, affecting the macroeconomic outlook in India.

India, as a result, will experience deterioration in its balance of payments, putting downward pressure on exchange rates.

Ultimately, imports would become more expensive and exports less valuable, leading to a drop in real national income.

Inflation soars

Higher oil prices generates a cost push inflation, leading to increased input costs, reduced non-oil demand and lower investment in net oil importing countries. Also, tax revenues tend to fall and the budget deficit increases, due to rigidities in government expenditure, which drives interest rates up.

India’s food inflation stood at 9.18% for the week ended March 26.  For the past 17 months, food retailers have been feeling the pinch of higher food prices more than consumers, and it looks like that will continue even longer.

How does inflation affect an economy of a nation?

The economic system of the country relies on the value of the money they use to stay the same. For example, imagine going to the store and purchasing a bar of chocolate for Rs 10, only to have the attendant tell you the bar now costs Rs 25 dollars. The chocolate bar hasn’t gotten more expensive, your money is simply worth less. The primary reason that inflation affects the economy so negatively is the loss of value.

Inflation impacts the economy so significantly because economies are organized based on the value of currency, both within and outside of the country.

The International Monetary Fund, however, said that though soaring oil prices and inflation in emerging economies pose new risks to economic recovery, it is not yet strong enough to derail the economy.