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

The Energy Information Administration (EIA)
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
oil prices the problem tends to get
compounded.
Government Owned Oil Marketing
Companies (OMCs) in India sell petroleum
products (excluding Petrol) at a subsidized rate.
The losses incurred by these companies are
called “Under Recoveries”. The Government of
India compensates the OMCs for these under
recoveries either through cash payment or issue
of bonds.
Under recoveries of OMCs for the FY 2008-09
were Rs. 1,03,292 Crores[5]. The Government
issued oil bonds to the tune of Rs. 71,292 Crores
whereas the remaining burden of Rs. 32,000
Crores was shared by Upstream Oil Companies[6].
Even after compensation by the government
& Upstream Oil Companies, the combined net
profit of IOC, BPCL and HPCL during FY 2004-05
to FY 2008-09 declined by 60 % [7].
As the authorized private sector OMCs, viz.
Reliance Industries, Essar Oil and Shell India
were not part of the above subsidy sharing
arrangement they closed down their retail
marketing business across the country.
Fixation of prices of these essential
commodities by the Government at different
points of time leads to speculations, hoarding,
temporary shortages and above all diversion of
Diesel, LPG, and Kerosene to unintended uses.
IMPACT OF RISE IN CRUDE OIL PRICES ON
INDIA’S GDP GROWTH (% Change)
SOURCE: FICCI

ECONOMIC IMPACT OF RISE IN OIL PRICES
India’s huge dependence on Imported Crude
Oil makes it vulnerable to the shocks &
disruptions in the Global Oil Market.
But the overall impact of the high oil prices
on the Indian economy is restrained by factors
like the comfortable balance of payment
position, the large foreign exchange reserves
and the access to international capital. These
parameters have improved substantially in
India’s favor as compared to the previous
period of high oil prices.
However, any sharp spike in oil prices in the
global market results in an unfavorable
economic situation. The reasons for the same
are outlined below.
a) RISE IN COST OF IMPORTS: The first victim
of rise in crude oil prices is the state
exchequer. Every increase of $1 per barrel in
Indian crude basket prices pushes up the
annual oil import bill by $1.2 billion [8]. It also
leads to a faster depletion of India’s Foreign
Exchange (FOREX) Reserves.
b) WIDENING OF TRADE DEFICIT: India’s trade
deficit for 2009-10 was $117.3 billion [9]. The
steep increase in imports due to high oil
prices leads to a further widening of the
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
RBI) & Reverse Repo Rate (the rate at
which RBI borrows money from the
banks). As a consequence of rise in these
key rates, banks are left with lesser
funds to lend to their customers.
Thereby sucking out the excess liquidity
in the economy. Banks are forced to
follow suit & increase the cost of loans
to its customers. A hike in interest rates
also attracts foreign capital flows which
may lead to appreciation of the Indian
Rupee. Such appreciation dampens the
profitability of Indian exporters, at times
forcing them to shut shop.
d) CAPEX POSTPONEMENT: Corporate India
largely relies on borrowings from banks
for business expansion. In view of
inflationary trends & dearer cost of
funds, corporate India puts it Capital
Expenditure (CAPEX) plans in the cold
storage. The idea is to wait for the
inflation & interest rates to come down
before initiating any new projects.
e) REDUCTION IN CREDIT GROWTH: A reduced
level of investment in the economy due
to increase in interest rates leads to a
slowdown in the credit growth (Loan
Disbursement) of banks, the lubricant of
every economy.
f) FALL IN EMPLOYMENT OPPORTUNITIES: As
business activity in the economy takes a
hit, generation of employment
opportunity also suffers a setback.
g) SLOWDOWN IN ECONOMIC GROWTH: A
sustained rise in interest rates in the
economy begins to hurt the economic
growth. Reduced investment, lower
spending on infrastructure & fall in
domestic consumption of goods &
services puts a break on the growth of
the economy.

IMPACT ON KEY SECTORS
The performance of business enterprises
across the country is affected due to
increase in fuel prices in the domestic
economy. But some sectors suffer a greater
loss as compared to the others. They include
the Automobile Industry (dearer personal
loans leading to fall in sales), FMCG Sector
(erosion of profit margins due to rise in cost
of raw materials), Banking Industry (slow
down in credit growth), Civil Aviation
Industry (rise in price of Aviation Turbine
Fuel), Oil Refining Industry (higher under
recoveries), Paint Industry (crude oil is a
major input for solvent based paints) and
many others. Incidentally, the above
mentioned sectors also figure in the list of
sectors which provide high direct & indirect
employment opportunities.

NEED FOR REFORMS
It is imperative that the Indian
government brings about the necessary
reforms to strengthen the domestic oil
market.
The key reforms include: (1) Rational
pricing of petroleum products, (2) Reducing
taxation on petroleum products & tapping
alternative sources of revenue to
compensate the loss due to reduced
taxation & (3) Removal of entry barriers for
private players in distribution and retail
business in order to create real market
competition.
As the Indian Economy treads the path of
growth, its appetite for crude oil as a crucial
source of energy will only increase. Given
India’s chronic dependence on imported
crude oil, the Indian Economy’s fuel import
bill will continue to remain vulnerable &
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