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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
"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. Despite
CRUDE OIL PRICE TRENDS 2000-2010
2010 (US$ Per Barrel)
the global financial crisis, India’s
energy demand continues to rise.
But India faces formidable
challenges in meeting
ing 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% of India’s
commercial energy requirements [1]. In
2009, India with a consumption of 3
rels per day was the 4th
million barrels
largest oil consumer in the world after
the United States, China, and Japan [2].
SOURCE: National Energy Board, Canada India’s proven
roven reserves of crude oil
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
gely relies on imported crude oil to
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
b per
200,000 248,226
day, or about 70 %,, of its oil needs as
150,000 117,003
171,702 compared with 44 % in 1995 [3].
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
07 2007-08 2008-09 2009-10* by Iran [4].

SOURCE: Annual Report 2009-10,


10, Ministry Of Petroleum & Gas
*: 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 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 SOURCE: FICCI
oil prices the problem tends to get
compounded.  ECONOMIC IMPACT OF RISE IN OIL PRICES
Government Owned Oil Marketing India’s huge dependence on Imported Crude
Companies (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 prices
called “Under Recoveries”. The Government of on the Indian economy is restrained by factors
India compensates the OMCs for these under like the comfortable balance of payment
recoveries either through cash payment or issue position, the large foreign exchange reserves
of bonds. and the access to international capital. These
Under recoveries of OMCs for the FY 2008-09 parameters have improved substantially in
were Rs. 1,03,292 Crores[5]. The Government India’s favor as compared to the previous
issued 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 the
Crores was shared by Upstream Oil Companies[6]. 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 victim
to FY 2008-09 declined by 60 % [7]. of rise in crude oil prices is the state
As the authorized private sector OMCs, viz. exchequer. Every increase of $1 per barrel in
Reliance Industries, Essar Oil and Shell India Indian crude basket prices pushes up the
were not part of the above subsidy sharing annual oil import bill by $1.2 billion [8]. It also
arrangement they closed down their retail leads to a faster depletion of India’s Foreign
marketing business across the country. Exchange (FOREX) Reserves.
Fixation of prices of these essential b) WIDENING OF TRADE DEFICIT: India’s trade
commodities by the Government at different deficit for 2009-10 was $117.3 billion [9]. The
points of time leads to speculations, hoarding, steep increase in imports due to high oil
temporary shortages and above all diversion of prices leads to a further widening of the
Diesel, LPG, and Kerosene to unintended uses. trade deficit.
c) INCREASE IN OIL U NDER RECOVERIES: As the  IMPACT OF HIKE IN FUEL PRICES IN THE
pricing of Diesel, LPG & Kerosene is still DOMESTIC MARKET
under government control, any rise in
A sustained rise in international crude oil
international 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 to
sell fuel at the market defined rate results in
allow the subsidy bill to inflate in times of global
higher under recoveries.
supply shocks & disruptions. In such cases, the
d) MOUNTING FUEL SUBSIDY BURDEN: Any
government passes on the burden to the
hike in price of imported crude oil is
consumers by allowing the OMCs to hike the
absorbed by the OMCs along with the
fuel prices in the domestic market. The hike in
Upstream Oil Companies & the federal
fuel prices has a cascading effect on the Indian
government. 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 direct
years. From FY 2005-06 to FY 2008-09,
impact on the prevailing inflation rate in
Government’s fuel subsidy bill amounts to
the economy. Higher fuel prices (in
Rs. 1,42,203 Crores [10].
particular Diesel) lead to increase in
e) 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 essential
Domestic Product (GDP) [11]. Rise in crude oil
commodities (such as food items,
prices worsens the situation as Government
cement, coal etc) shoots up. Inflationary
has to shell out more money in the form of
expectations among traders lead to
fuel subsidy to OMCs.
hoarding which pushes the spiraling
f) REDUCED AMOUNT FOR INFRASTRUCTURE
inflation rate further up.
INVESTMENT: India aims to invest $1 Trillion in
b) EROSION O F PROFIT MARGINS: Rise in
infrastructure development during the 12th
inflation rate in turn leads to erosion of
Five Year Plan (2012-17) [12]. High prices of
profit margins of business enterprises as
crude oil (leading to higher fuel subsidy &
the key inputs for business become
increase in fiscal deficit) have the potential
costlier & consumers reduce their
to derail the government’s plans as they eat
spending. Inevitably, the earnings growth
into the amount of disbursal available with
of corporate India slows down.
the government for infrastructure & social
c) HIKE IN INTEREST RATES: The Reserve
development 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 periodic
worsening fiscal deficit has forced the
Monetary Policy review. In case of
federal government to deregulate the petrol
inflation zooming beyond the comfort
prices in the domestic market while in-
zone, the RBI steps in to bring it down to
principle approval has been given for
an acceptable level. It does so by
deregulation of diesel prices. However, the
increasing the Cash Reserve Ratio (a
Government reserves the right to intervene
portion of deposits which banks have to
whenever 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) and
d) 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 oil
e) 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 reduced
f) 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.
 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