Crude oil prices play a very significant role on the economy of any country. India’s growth story hovers around the import of oil as India imports 70% of its crude requirements. In this paper, an attempt has been made to study the impact of crude oil price on the Indian economy by considering Gross Domestic Product (GDP), Index of Industrial Production (IIP) and Wholesale Price Index (WPI) as the relevant variables. Vector Auto Regression (VAR) has been used to analyse the objective since a direct causal relationship could not be established.
The recent rise in the prices of crude oil has drawn everyone’s attention towards the crucial role that oil plays in the economy of any nation. Crude oil is one of the most necessitated commodities in the world and India imports around 100 million tons of crude oil and other petroleum products. This in turn, results in spending huge amounts of foreign exchange. The increasing quantum of imports of petroleum products has a significant impact on the Indian economy, especially when crude oil prices are shooting up globally. Crude oil not only serves as a source of energy but also as a major raw material to various industries. With no major discoveries in the recent years, the increasing costs of production have pushed up crude oil prices globally. Also, the high volatility in the prices of oil breaching the $100/barrel mark and rising to a high of $147/barrel could be attributed to the fact that in the recent years, many index funds have taken positions in commodities considering oil to be an asset stock in their portfolios. It has been usually observed that in India, the pricing scheme is designed in such a way that it offers a system to moderate the soaring international oil prices and thereby study the impact on growth, inflation, etc.
In spite of the global economy being affected due to the European debt crisis, crude oil prices are soaring against a backdrop of increasing tensions around the situation in Iran. The price of Brent crude has gone beyond $120 per barrel. This spike in crude oil price significantly increases the energy costs of every country and becomes a major concern in the fragile global economy.
The impact of rising oil prices on the economy differs from country to country depending upon individual energy supply and demand structures. Countries that could be adversely affected by the increase in crude oil price are usually characterized by high net imports of oil per GDP. Traditionally, the non-oil producing developing countries fall under this category. Against this background, developed countries are more economical in their usage of oil and therefore, see an easing of this adverse effect of rise in crude oil prices. This phenomena has led to many European developed countries enjoying a significant inflow of oil money.
Today, we may find a negative impact of rise in crude oil prices. A steep fall in the current accounts leads to further worsening of the treasury budgets, which, in turn, will further worsen the balance between savings and investments. Also, reducing tax revenues and other extraneous factors will further deteriorate the treasury budgets. Due to the economic crisis in Europe, where the treasury budgets have shaken, there is a monumental imbalance between savings and investments. These imbalances continue worsening because of rising crude oil prices, which threaten to push the economy into much deeper crisis. When a country has a fixed nominal exchange rate and there is also an output gap, increases in oil prices leads to an increase in the general price levels. According to a RBI report (2005), for every unit dollar increase in crude oil price, WPI inflation rises by 30 basis points. Kaushik Bhattacharya et al. (2005) analysed the impact of increase in oil price on inflation. They studied the mechanism of increase in the prices of petroleum products on the prices of other commodities and the output in India. In February 1999, from an all time low of 11 U.S Dollars per barrel, it increased to a peak of 35 dollars in the first week of September 2000. Due to this, all oil importing countries faced the threat of oil shock; India, being a major oil importer, was particularly affected.