OIL: WHAT LIES BENEATH

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: India is scared. And this has a lot to do with oil prices. High oil prices lead to inflation which in turn leads to higher interest rates. The US Fed is facing sleepless nights because of high oil prices and its reactions are panic-driven. By the end of June, Ben Bernanke, the Fed chief, is expected to drive interest rates higher to scare off inflation.

A hike in US interest rates is likely to start an upward spiral in interest rates in emerging markets; but for different reasons. While the US economy is a stagnating economy, it has a lot to get scared of because of increasing oil prices.

“Last year a lot of damage was caused to refineries in the US due to hurricanes. This year as a preventive measure the refineries, especially ones on the US gulf coast, might scale down operations in both the refineries and oil producing wells. With very few sparing capacity left, this can have substantial impact on the prices,” Raj Gandhi, analyst- oil and gas, Angel Broking.

But for India and China, that is not the case. Even when oil prices were surging, these economies recorded the highest GDP growth rates ever. In fact, the oil prices were moving up on higher demand and not because of depleting supply, as is popularly believed.

Says an economist at broking firm, ICICI Securities, "Unlike earlier times when the economy used to tank on account of rise in oil prices, today the economy is not much affected since the oil prices are not fully passed on. In response to spiraling oil prices, the government recently raised the gasoline and diesel prices by almost 9.2% and 6.6% respectively. The direct impact of these fuel prices is expected to be low for inflation as the combined weight of these two in the inflation basket is put at only 3%."

Analysts in Indian broking firms feel that in the short term there could be one more round of oil price hike. However, oil prices were high last year as well. Due to the base effect, the rise in oil prices will not have significant impact on inflation, which is expected to remain at a moderate 5%.

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