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:

amit.rajani1988@gmail.com

83,528

117,003171,702

219,029

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

2003-04 2004-05 2005-06 2006-07

CRUDE OIL PRICE TRENDS 2000-2010 (US$ Per Barrel)

SOURCE: National Energy Board, Canada

SOURCE: Annual Report 2009-10, Ministry Of Petroleum & Gas

*: Up to December 2009

INDIA’S CRUDE OIL IMPORTS (in Rs.

"IMPACT OF RISE IN CRUDE

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. Despite

the global financial crisis, India’s

energy demand continues to rise.

But India faces formidable

challenges in meeting its energy needs

and in providing adequate energy of

desired quality in various forms in a

sustainable manner and at

competitive prices.

Oil meets about 24%

commercial energy requirements

2009, India with a consumption of 3

million barrels per

largest oil consumer in the world after

the United States, China, and Japan

India’s proven reserves of

and oil production have

any significant improvement

last few decades. As a result,

largely relies on imported crude oil to

meet its energy requirements

In 2009, India was the

net importer of oil in the world,

importing nearly 2.1 million b

day, or about 70 %, of its oil needs as

compared with 44 % in 1995

Nearly 70 % of India’s crude oil

imports come from the Middle East,

primarily from Saudi Arabia, followed

by Iran [4].

272,699

348,288

248,226

07 2007-08 2008-09 2009-10*

2010 (US$ Per Barrel)

National Energy Board, Canada

10, Ministry Of Petroleum & Gas

Up to December 2009

(in Rs. Crores)

RUDE OIL PRICES ON

CONOMY”

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

With high economic growth rates

and over 15 percent of the world’s

population, India is a significant

consumer of energy resources. Despite

the global financial crisis, India’s

energy demand continues to rise.

But India faces formidable

ing its energy needs

and in providing adequate energy of

desired quality in various forms in a

sustainable manner and at

Oil meets about 24% of India’s

requirements [1]. In

2009, India with a consumption of 3

rels per day was the 4th

largest oil consumer in the world after

the United States, China, and Japan [2].

roven reserves of crude oil

and oil production have not witnessed

any significant improvement in the

. As a result, India

gely relies on imported crude oil to

requirements.

In 2009, India was the 6th largest

net importer of oil in the world,

importing nearly 2.1 million barrels per

, of its oil needs as

% in 1995 [3].

of India’s crude oil

imports come from the Middle East,

primarily from Saudi Arabia, followed

The Energy Information Administration (EIA)

expects India to become the 4th largest net

importer of oil in the world by 2025, behind the

United States, China, and Japan.

� OIL UNDER RECOVERIES

The dependence on crude oil imports is

chronic for a developing country like India as

India's current resource utilisation pattern does

not contain alternatives to imported crude.

Furthermore, in a situation of unabated rise in

oil prices the problem tends to get

compounded.

Government Owned Oil Marketing

Companies (OMCs) in India sell petroleum

products (excluding Petrol) at a subsidized rate.

The losses incurred by these companies are

called “Under Recoveries”. The Government of

India compensates the OMCs for these under

recoveries either through cash payment or issue

of bonds.

Under recoveries of OMCs for the FY 2008-09

were Rs. 1,03,292 Crores[5]. The Government

issued oil bonds to the tune of Rs. 71,292 Crores

whereas the remaining burden of Rs. 32,000

Crores was shared by Upstream Oil Companies[6].

Even after compensation by the government

& Upstream Oil Companies, the combined net

profit of IOC, BPCL and HPCL during FY 2004-05

to FY 2008-09 declined by 60 % [7].

As the authorized private sector OMCs, viz.

Reliance Industries, Essar Oil and Shell India

were not part of the above subsidy sharing

arrangement they closed down their retail

marketing business across the country.

Fixation of prices of these essential

commodities by the Government at different

points of time leads to speculations, hoarding,

temporary shortages and above all diversion of

Diesel, LPG, and Kerosene to unintended uses.

� ECONOMIC IMPACT OF RISE IN OIL PRICES

India’s huge dependence on Imported Crude

Oil makes it vulnerable to the shocks &

disruptions in the Global Oil Market.

But the overall impact of the high oil prices

on the Indian economy is restrained by factors

like the comfortable balance of payment

position, the large foreign exchange reserves

and the access to international capital. These

parameters have improved substantially in

India’s favor as compared to the previous

period of high oil prices.

However, any sharp spike in oil prices in the

global market results in an unfavorable

economic situation. The reasons for the same

are outlined below.

a) RISE IN COST OF IMPORTS: The first victim

of rise in crude oil prices is the state

exchequer. Every increase of $1 per barrel in

Indian crude basket prices pushes up the

annual oil import bill by $1.2 billion [8]. It also

leads to a faster depletion of India’s Foreign

Exchange (FOREX) Reserves.

b) WIDENING OF TRADE DEFICIT: India’s trade

deficit for 2009-10 was $117.3 billion [9]. The

steep increase in imports due to high oil

prices leads to a further widening of the

trade deficit.

IMPACT OF RISE IN CRUDE OIL PRICES ON

INDIA’S GDP GROWTH (% Change)

SOURCE: FICCI

c) INCREASE IN OIL UNDER RECOVERIES: As the

pricing of Diesel, LPG & Kerosene is still

under government control, any rise in

international oil prices is not reflected in the

domestic market. The inability of OMCs to

sell fuel at the market defined rate results in

higher under recoveries.

d) MOUNTING FUEL SUBSIDY BURDEN: Any

hike in price of imported crude oil is

absorbed by the OMCs along with the

Upstream Oil Companies & the federal

government. The fuel subsidy bill has

witnessed a continuous rise for the past few

years. From FY 2005-06 to FY 2008-09,

Government’s fuel subsidy bill amounts to

Rs. 1,42,203 Crores [10].

e) WORSENING FISCAL DEFICIT: India’s Fiscal

Deficit for 2009-10 stood at 6.6 % of Gross

Domestic Product (GDP) [11]. Rise in crude oil

prices worsens the situation as Government

has to shell out more money in the form of

fuel subsidy to OMCs.

f) REDUCED AMOUNT FOR INFRASTRUCTURE

INVESTMENT: India aims to invest $1 Trillion in

infrastructure development during the 12th

Five Year Plan (2012-17) [12]. High prices of

crude oil (leading to higher fuel subsidy &

increase in fiscal deficit) have the potential

to derail the government’s plans as they eat

into the amount of disbursal available with

the government for infrastructure & social

development schemes.

A continuous rise in the subsidy bill &

worsening fiscal deficit has forced the

federal government to deregulate the petrol

prices in the domestic market while in-

principle approval has been given for

deregulation of diesel prices. However, the

Government reserves the right to intervene

whenever the situation demands.

� IMPACT OF HIKE IN FUEL PRICES IN THE

DOMESTIC MARKET

A sustained rise in international crude oil

prices leads to bleeding of the state exchequer.

It becomes untenable for the government to

allow the subsidy bill to inflate in times of global

supply shocks & disruptions. In such cases, the

government passes on the burden to the

consumers by allowing the OMCs to hike the

fuel prices in the domestic market. The hike in

fuel prices has a cascading effect on the Indian

Economy. The same is explained below.

a) INFLATION: Rise in fuel prices has a direct

impact on the prevailing inflation rate in

the economy. Higher fuel prices (in

particular Diesel) lead to increase in

transportation costs across the country.

As a result of which the price of essential

commodities (such as food items,

cement, coal etc) shoots up. Inflationary

expectations among traders lead to

hoarding which pushes the spiraling

inflation rate further up.

b) EROSION OF PROFIT MARGINS: Rise in

inflation rate in turn leads to erosion of

profit margins of business enterprises as

the key inputs for business become

costlier & consumers reduce their

spending. Inevitably, the earnings growth

of corporate India slows down.

c) HIKE IN INTEREST RATES: The Reserve

Bank of India (RBI) is entrusted with the

responsibility of containing inflation in

the Indian economy through periodic

Monetary Policy review. In case of

inflation zooming beyond the comfort

zone, the RBI steps in to bring it down to

an acceptable level. It does so by

increasing the Cash Reserve Ratio (a

portion of deposits which banks have to

keep with the RBI), Repo Rate (the rate

at which banks borrow funds from the

RBI) & Reverse Repo Rate (the rate at

which RBI borrows money from the

banks). As a consequence of rise in these

key rates, banks are left with lesser

funds to lend to their customers.

Thereby sucking out the excess liquidity

in the economy. Banks are forced to

follow suit & increase the cost of loans

to its customers. A hike in interest rates

also attracts foreign capital flows which

may lead to appreciation of the Indian

Rupee. Such appreciation dampens the

profitability of Indian exporters, at times

forcing them to shut shop.

d) CAPEX POSTPONEMENT: Corporate India

largely relies on borrowings from banks

for business expansion. In view of

inflationary trends & dearer cost of

funds, corporate India puts it Capital

Expenditure (CAPEX) plans in the cold

storage. The idea is to wait for the

inflation & interest rates to come down

before initiating any new projects.

e) REDUCTION IN CREDIT GROWTH: A reduced

level of investment in the economy due

to increase in interest rates leads to a

slowdown in the credit growth (Loan

Disbursement) of banks, the lubricant of

every economy.

f) FALL IN EMPLOYMENT OPPORTUNITIES: As

business activity in the economy takes a

hit, generation of employment

opportunity also suffers a setback.

g) SLOWDOWN IN ECONOMIC GROWTH: A

sustained rise in interest rates in the

economy begins to hurt the economic

growth. Reduced investment, lower

spending on infrastructure & fall in

domestic consumption of goods &

services puts a break on the growth of

the economy.

� IMPACT ON KEY SECTORS

The performance of business enterprises

across the country is affected due to

increase in fuel prices in the domestic

economy. But some sectors suffer a greater

loss as compared to the others. They include

the Automobile Industry (dearer personal

loans leading to fall in sales), FMCG Sector

(erosion of profit margins due to rise in cost

of raw materials), Banking Industry (slow

down in credit growth), Civil Aviation

Industry (rise in price of Aviation Turbine

Fuel), Oil Refining Industry (higher under

recoveries), Paint Industry (crude oil is a

major input for solvent based paints) and

many others. Incidentally, the above

mentioned sectors also figure in the list of

sectors which provide high direct & indirect

employment opportunities.

� NEED FOR REFORMS

It is imperative that the Indian

government brings about the necessary

reforms to strengthen the domestic oil

market.

The key reforms include: (1) Rational

pricing of petroleum products, (2) Reducing

taxation on petroleum products & tapping

alternative sources of revenue to

compensate the loss due to reduced

taxation & (3) Removal of entry barriers for

private players in distribution and retail

business in order to create real market

competition.

As the Indian Economy treads the path of

growth, its appetite for crude oil as a crucial

source of energy will only increase. Given

India’s chronic dependence on imported

crude oil, the Indian Economy’s fuel import

bill will continue to remain vulnerable &

sensitive to fluctuations in world oil prices.

� REFERENCES

[1], [2], [3], [4]

“India Energy Data, Statistics & Analysis” – U.S

Energy Information Administration

[5], [6], [7], [10]

“Report of the Expert Group on A Viable and

Sustainable System of Pricing of Petroleum

Products”, Government of India

[8], [9]

http://www.businessworld.in/bw/2010_07_02_

Indias_Trade_Deficit_Expected_To_Widen.html

[11]

http://business-standard.com/india/news/2009-

10-fiscal-deficit-stands-at-66gdp/396788/

[12]

http://www.livemint.com/2010/03/23213711/

Government-plans-1-trillion-s.html