The renewed escalation of tension between the US and Iran, along with Houthi attacks on the Red Sea, has once again pushed the benchmark Brent crude price.

Confusion over a peace deal between the US and Iran continued, though US President Donald Trump said Washington cancelled the planned attacks on Iran and that talks were on course. Iran, however, gave no indication of any such development.  

The seesawing situation may keep oil prices high. Additionally, shrinking US oil inventories are also building pressure on prices.

 In July, international crude prices breached the psychological mark of US$ 100 per barrel yet again, making economic management difficult for policymakers who would need to tweak mechanisms to neutralise the impact of the global crisis, keep inflation under check and deal with the prospect of a below-normal monsoon.

Though at present it is hovering below US$90 a barrel, with global risks rising, worries are building up.

The near triple-digit crude price in the global market would push the cost of transport, hitting family budgets directly and indirectly. The worst impacted would be the rural India ecosystem and the urban middle class. But the repercussions will leave a dent for India’s corporate sector as well as smaller businesses.

The Macro Impact

Of course, at the macro level, the fallout of the spike in crude oil prices will leave a deeper imprint on India’s economic growth, exchange rate, stock and money markets, current account deficit and also the fiscal deficit. 

Most importantly, it will impact jobs.

With four months already down in the first half of the current financial year, the budgetary calculations and management of monetary policy by the Reserve Bank of India (RBI) will have to be reassessed.

Ramifications on portfolio investments by foreign institutional investors and Foreign Direct Investment (FDI), which the country has been trying to attract in larger quantities through a host of fiscal and non-fiscal measures, could also dent the economy until appropriate policy measures are put in place at the earliest.

“Until now, we haven’t seen any major change in the policy framework, but going ahead we need to see how things shape up and the impact it leaves on the country’s macro indicators,” Montek Singh Ahluwalia, former Deputy Chairman of the erstwhile Planning Commission, told The Secretariat.

West Asia Crisis, Crude Oil Prices

Oil shocks are not new to either the world or India. Several oil shocks were witnessed in the past, causing crippling effects on the Indian economy. The first major oil shock was witnessed in the 1970s following the imposition of an embargo by OPEC. It had severe repercussions, especially concerning inflation.  The oil shock following the Gulf War in 1990 had a far-reaching impact on the Indian economy.  The crisis triggered the famous economic reforms of 1991, unleashed by the then Finance Minister Manmohan Singh. He later became the Prime Minister of the country.

Crude oil prices had crossed US$100 a barrel in 2014 too—between January and June before drastically collapsing.

This time again, the oil shock emanated from the developments in West Asia. The crude oil prices hit the roof after the US and Israel launched an attack on Iran in February. Iran retaliated by attacking oil infrastructure in the Gulf region. The subsequent closure of the Strait of Hormuz added fuel to the fire.  The benchmark Brent crude spiked well above US$100 a barrel.  

Thereafter, the truce pulled down crude prices, and the world took a sigh of relief. It dipped to around US$70-75 a barrel in early July. The fragile peace deal has yielded little results.

Resumption of air strikes, attacks by Iran-backed Houthis on Saudi oil infrastructure and blockade of the Strait of Hormuz stoked crude prices, which breached the US$100-a-barrel mark again last month.

Impact On Prices, Household Budgets

For India, which imports more than 88 per cent of its crude oil requirement, the trend is particularly worrisome.

As regards cooking gas, before the outbreak of conflict in the Middle East in February, India used to import about 60 per cent of its LPG consumption, out of which about 90 per cent transited through the Strait of Hormuz. Hence, any price increase in the global market or blockade of the Strait of Hormuz has its ramifications for the domestic economy in the immediate and medium term. The immediate transmission to retail pump prices of petrol and diesel may be delayed due to political reasons, by reducing duties on petroleum products. Sometimes the high crude prices are absorbed temporarily by the oil companies. Whatever is done, the broader inflationary pressures are unavoidable, especially in the medium term.  They, willy-nilly, act as a regressive tax impacting the whole supply chain, making goods dearer from vegetables to automobiles.

Elevated crude also pushes the price of Aviation Turbine Fuel (ATF), increasing freight and transportation charges. This translates into a broad-based surge in the Wholesale Price Index (WPI), which eventually spills over to the Consumer Price Index (CPI) at the retail level. The ultimate burden has to be borne by the end consumer.

Similar is the story of cooking gas. If the prices go up in the international market, someone will have to bear the burden. Whether it is the exchequer, oil market companies, or consumers, wholly or partially.

“With the closure of the Strait of Hormuz (In April and May), supplies of imported LPG were severely constrained. The Government took a series of proactive measures to ensure stability in LPG supplies post the outbreak of the conflict. These include a rapid increase in production of LPG from 34 to 54 TMT per day, prioritisation of household usage of LPG, diversification of import sources, dynamic stock management, inter-regional allocation to address localised shortages,” Minister of State for Petroleum and Natural Gas Suresh Gopi has said while replying to a question in Parliament.

Driven by rising prices of energy, the Wholesale Price Index (WPI) in June rose by 9.87 per cent. Of significance is the wholesale inflation in the energy sector. The WPI inflation in the fuel and power segment was up by 27.41 per cent. The rise was 46.48 per cent in the case of mineral oil and 34.75 per cent in crude petroleum and natural gas. Given the ongoing problems in West Asia, the WPI is likely to soon breach the double-digit mark. With some lag, the high WPI inflation will spill over to the Consumer Price Index (CPI) or retail prices, impacting household budgets.

A below-normal monsoon, as predicted by the India Meteorological Department (IMD), at this juncture will add to the woes of policymakers trying to keep prices under check.

According to Reserve Bank Governor Sanjay Malhotra, “the partial pass-through of high global crude oil prices to domestic pump prices of petrol and diesel started in May. Prices of several inputs such as commercial LPG, industrial raw materials, chemicals, base metals, rubber, and plastic products, among others, have increased. These could exert upward pressure on CPI inflation in the coming months as firms pass on higher input costs.”