GS Paper 3
Syllabus: Indian Economy and issues
Source: Indian Express
Direction: This is an editorial explainer, detailing the implications of Oil and Dollar fluctuation on the Economy.
Context: Russia-Ukrain crisis and US Fed monetary tightening have impacted import-dependent countries like India.
Correlation Between Oil and US Dollar:
The U.S. dollar is the standard currency used to pay for oil globally, prompted by an agreement between the U.S. and Saudi Arabia in 1945. Countries that buy crude oil and those that produce it exchange DOLLAR in a system called the petrodollar system.
As the USA shifted from being a net importer to a net exporter of energy in 2020 and was the largest global producer in 2021. A rise in Oil prices helps the US earn more revenue and thus makes the US dollar stronger.
India’s Oil Import/Consumption:
India is the world’s third-largest oil consumer at around 5 million barrels a day (almost 86% of its need is imported), behind the US and China. The Middle East accounts for 60% of all oil bought by India while Latin America and Africa are the other big supplier blocks.
Implications of High oil prices for India:
- Increases the import bill:
- Crude has a share of 30-33 per cent in total imports and any hike in prices increases the import bill, thus negatively affecting India’s Current Account Deficit and increasing India’s fuel subsidies.
- A current account deficit indicates that a country is importing more than it is exporting
- Any increase in Crude Oil prices directly increases Inflation (unless subsidised by the government).
- Inflation in imports:
- With a weaker Indian currency, all imported items will be more expensive in rupees, forcing the RBI to take further action. However, RBI’s measure will lead to a decrease in India’s forex reserves.
- User industries of oil like chemicals, plastics and fertilisers will face a problem again. Higher input costs will put pressure on profit margins and any pass-through will be inflationary.
- 5. States and centre’s tax revenue:
- The state governments will be better off as their VAT collections would increase automatically with an increase in Oil prices. However, the Centre may not gain as the excise duty is a fixed rate e.g. Rs. 3.4 Per litre.
- Bond yields:
- Bond yields move up every time oil prices rise while stock markets turn volatile normally in the downward direction. As a consequence, economic uncertainty will intensify once again.
- The yield of a bond is the interest rate investors earn when they buy the bond.
The problem with rising oil prices and a declining rupee is that these are external to the system over which there is little control. The RBI’s intervention and protection of currency have their limitations. These travails have to be responded to as they cannot be controlled.
Therefore, India needs to reduce its dependence on imported oil (e.g. use of renewables, use of bio-fuels) and also increase its export capacity to reduce any impact on its currency. Further India should go for increased use of the Indian Rupee for International trade.
What Is the Balance of Trade (BOT)?
Balance of trade (BOT) is the difference between the value of a country’s exports and the value of a country’s imports for a given period. Balance of trade is the largest component of a country’s balance of payments (BOP).
Balance of Payments (BOP):
The balance of payments (BOP), is a statement of all transactions made between entities in one country and the rest of the world over a defined period, such as a quarter or a year.
- What is a Current Account Deficit (CAD)?
- Balance of Payments
- Balance of trade
- About Petrodollar System
Q. Policymakers have little control over the dollar and crude oil. It is impossible to take a call on how these prices will move. Explain.