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Crude oil, which is an important factor in the global geo-politics, is seeing wide swings in the international market. From record highs, it has now fallen to record lows, surprising the world. Since June 2014, there has been a staggering 40% drop in the oil price -- from $115 per barrel to below $50.
Two main factors that determine the price of crude oil are, first, the basic economic principle of supply and demand and second, expectation -- the amount of oil that could be purchased on the international market at a given point of time. Demand is also influenced by weather conditions. During winter, the demand spikes in the southern hemisphere and countries that use air conditioning have a significantly greater need during summer. Weakening of economies world over, an investment drought, growing efficiency of vehicles and a switch from oil to more sustainable sources of power have all resulted in sharp decline in demand.
The Organization of the Petroleum Exporting Countries (OPEC) is no longer the largest producer of crude oil. That title is now held by the USA, earlier a huge importer. Though the United States doesn't export the oil they produce, they aren't buying either. Considering they were a major buyer, 9-10 million barrels per day, it is no great surprise that the price has dropped as there is a lot more surplus oil available for sale. Countries like Iraq and Iran, which were pre occupied with internal conflict, have now become stable enough to start supplying again. The massive increase in oil prices earlier had resulted in large investments in oil exploration and drilling. All these factors led to a jump in the supply. But there was no reciprocate rise in demand. Rather, there was a slump in demand, forcing oil prices way down.
Surprisingly, the OPEC members have decided not to curb production to regulate supply. Perhaps, they choose not to act because a restoration in the price of oil would mainly benefit countries that they detest -- like Russia and Iran. Saudi Arabia has $900 billion bank reserve and can easily bear the backlash of lower oil price. It remains to be seen if and when the fall in oil prices will stabilize and what the repercussions are for the various economies of the world.
Effects on India's economy
Oil is critical to India as it imports almost two thirds of its need. This constitutes 37% of its total imports. A $1 drop in oil prices could approximately save 40 billion rupees. For India, the drop in oil prices currently looks like a blessing but there could be some downslides too in the long run. The lower oil prices should be a much needed boost to GDP growth as it will reduce the household real disposable income, increase money available for policies oriented towards growth and also substantially add to corporate profit margins due to lower input costs. This might also motivate the corporate sector to invest more in the economy. It is estimated that if the price of oil falls about $4 per barrel, it would on an average shrink the trade deficit by $3 billion. This adding to the fact that India's trade deficit has already dropped to $7.5 billion, should help harden the rupee. It is a boon for the new Modi government and the timing, perhaps, could not be more ideal. The government will be able to mend the balance sheets and fulfil the huge mandate it has promised to the people much more easily.
This extra money and saving affords the central government the opportunity to keep its fiscal deficit well within the target of 4.1% of GDP. The drop has also allowed the government an opportunity to roll out some much needed and awaited fuel subsidy reforms, starting with scrapping the diesel subsidy which amounted to 0.3% GDP last year. The reduction in international crude oil prices will also sooth the effect of inflation to some extent, but whether it will be strong enough to make any significant effect remains to be seen.
All this may make this sound like exactly what India needed but there might well be a flip side. The previous year, ONGC and Oil India bought 10% in Mozambique gas for two and half billion dollars. Now with the fall in crude oil prices, analysts estimate the value going down by over 25%. All oil companies will take substantial hits. Oil assets take large investments to keep up their production and with the drop in the prices, their cash flow is bound to be lower. The rupee is estimated to fall against the dollar up to Rs.65. This would translate to burgeoning domestic companies paying much more for foreign loans they might have taken out.
Other possible downsides include the fact that countries with oil based economies will not be able to invest in India as their own purse strings would need to be tightened. Also the huge population of Indians in the Gulf could be affected if the Arab countries are hit.
India seems to be one of the few countries to be largely benefitted by the fall in oil price. But will the government take effective steps to utilise this opportune "bout of good fortune" and is it going to translate to real benefits for the common man? One can only hope that after a slew of bad times for the Indian economy, the Modi Government utilises this opportunity to its fullest and we reap the benefits of what is definitely a much needed "rain cloud" of luck in our otherwise stagnant economy.
By Special Arrangement with : Observer Research Foundation (www.orfonline.org)