Can India Withstand Another Oil Shock

Updated: Apr 28 2004, 05:30am hrs
India is a oil guzzling country. It is one of the top six oil consuming countries in the world. Hence, any spurt in oil prices in international market has repercussions on the economy. Brent crude price touched $38 per barrel in March, the highest ever increase since October 1990. By this time, the oil prices zoomed by over 35 per cent over the annual average of $28 per barrel in 2003. This sudden increase in crude price, coupled with OPECs averment for cut in production in order to counter the fall in prices, shocked several oil consuming countries who are dependent on oil import. Last year also, in February, oil prices skyrocketed due to the fear of the US-led war on Iraq. But the fear abated since the war was for short period.

This time round, the reasons for oil price hike are economic, and are not ephemeral. The surge in oil demand by China due to the boom in its economy and the USs plunge into big imports to pile up its strategic oil reserves in the fear of supply disruption geared up the OPECs temptation to raise the prices.

Whatever be the reason, whenever there is an oil price hike, fear looms over its impact on the economy in India, since 70 per cent of the countrys oil requirement is met by imports. However, there is one solace that even though India is an oil-guzzling nation, its direct impact on the output of major economic factors, such as agriculture and industry, is low. Notwithstanding this, oil is a strong determinant for Indias external economy. It is the single deterrent against abatement of import of the country. Oil and oil products( mainly crude oil) consume over one-fourth of Indias total import bill and is a heavy burden on the balance of payments position. The ballooning oil import bill fattened the total imports of the country by over 24 per cent during the first nine months of current fiscal year.

Paradoxically, this increase in oil import bill was not due to increase in volume imports, but due to the volatility of oil prices in the international market. In volume terms, import of crude oil made a slender growth by 5 to 6 per cent during the past two years, whereas in value terms, the increase was 25 per cent. In other words, oil has been the single factor for jeopardising the balance of payments, despite exports leapfrogging during these past two years. Therefore, can Indias shining economy be shielded even in the event of a rise in oil prices

Oil production remained stagnant over a period of eight to nine years at 32 to 33 million tonne per annum. With the rise in oil demand, the domestic requirement continued to depend more on imports. Indias GDP growth is projected to average 5.2 per cent per year till 2025, and oil demand is projected to grow by 4 per cent a year. This means, oil demand will rise to 274 million tonne in 2025. At present, the oil demand is 115 million tonne a year. The NELP (New Exploration Licensing Policy) is yet to prove its potential to meet the rising demand. At the present reckoning, Indias oil import dependency is bound to rise in next two to three years. Oil import dependency sharpened from 60 per cent in 1980-81 to 73 per cent in 2002-03.

No sooner did the oil prices skyrocket, analysts are fretting about rising inflation and turmoil in the balance of payments. These are the thumb rules of oil price hike. Does India really fall under these rules of oil price hike

Past experiences show that while oil shocks were a heavy burden on inflation in the 70s, the hikes unleashed a moderate impact on inflation and the economy in the country during the 80s and 90s. At the time of the first and second oil shocks in 1971 and 1979, inflation soared by 17 to 18 per cent a year. In the subsequent oil price hikes in the 90s, the volatility generated less vibration to the inflation in the country.

Another significant difference between the oil price hikes in 70s and 90s was that while the tenure of inflation was longer in the 70s, the duration of inflation was shorter in 2000. Against the 17 to 18 per cent inflation for over three to four years due to the second oil shock in 1979, the inflation of 7 per cent due to oil price hike in 2000 persisted for only one year. This has been plausible by the governments rigorous measures to contain the oil consumption through oil saving measures.

In India, oil price/supply volatility have less muscle to flex over the value addition of major economic sectors which contribute to the growth of the economy. Agriculture is the base for the Indian economy. And the oil dependency of agriculture is minuscule only 10 per cent. The major source of energy for agricultural growth is electricity. Nearly 90 per cent of the energy required for agriculture comes from electricity. Likewise, for industry, the main source of energy is coal - about 75 per cent. Oil dependency of industry is limited to 12 to 14 per cent only.

Further, electricity generation depends mainly on coal and hydro. Oil-based electricity is merely 3 per cent of total electricity generated every year. Therefore, the significance of oil in terms of direct contribution to the growth of GDP, which is flying high at 6 to 7 per cent, is veiled by the abundant availability of non-oil energy resources. Over 52 per cent of the total commercial energy is from coal. Oil contributes 34 to 35 per cent of total commercial energy.

Paradoxically, even though oil is the second major source of energy in the country, 75 per cent of it is used as transport fuel. It is true that cost of transport fuel has a greater impact on the price line since many of the goods are transported by trucks due to slow growth in rail transport. But the commendable improvement in oil-saving technology in automobiles has helped abate the spurt in oil demand. This was the reason that notwithstanding the spurt in Brent crude prices to $28 per barrel in 2000 from $18 per barrel in 1999, inflation remained contained during this period. Since April 2000, the price of diesel has gone up by 40 per cent and that of petrol by 23 per cent. But the growth of inflation was muzzled at 4 to 5 per cent a year during these period.

In sum, the structural composition of oil consumption and availability of abundant non-oil energy resources have insulated India from any major economic downturn due to oil price hike, despite its oil import dependency. Further, the boom in the foreign exchange reserves, as opposed to the situation in 1990 Gulf war, shields the country from being mired into any panic.

The writer is a senior researcher in a Japanese MNC based in New Delhi. The views here are personal.