Managing the crude price pressure

News: Russia-Ukraine conflict will have many economic implications for India, but higher commodity prices, particularly oil, will be most harmful.

In case the conflict prolongs, crude oil will be expected on an average around $100/barrel in 2022, vis-a-vis $70/barrel in 2021.

It would cost India 1.2 per cent of GDP i.e., for same net oil imports, India would be paying an incremental 1.2 per cent of GDP. This cost would rise, once higher prices for coal and gas imports are included.

How high oil prices will affect the Indian economy?

It will be like a supply shock to the economy, which impacts growth, inflation and the current account deficit (CAD), simultaneously.

It will have impacts on fiscal space, household purchasing power and firm’s margins. However, the distribution of impact will depend upon the policies. For example, the excise duty cuts last November absorbed about one-third of the shock from oil (0.4 per cent of GDP).

It will have imprint on India’s external balances. High oil prices can increase CAD. Although due to high foreign currency reserves, there is no imminent threat, but a close monitoring will be required.

High energy and other commodity prices will pressurize firms to eventually pass on input costs. Thus, inflation will increase in this case.

What are the policy measures that can be taken?

Monetary policy front: Widening of the CAD and associated BoP will create some depreciation pressures on the rupee. RBI should not intervene in this situation. Because, it will facilitate the necessary “expenditure switching” to reduce imports, boost exports and help narrow an elevated CAD.

Fiscal policies front: there are no easy or clear choices, government will have to take some hard decisions. Cutting excise duties will shrink the fiscal space to spend and encourage market. On the other hand, free flow in price increase would mean higher retail prices that can harden inflationary expectations.

Source: This post is created based on the article “Managing the crude price pressure” published in Indian Express on 4^th March 2022.