The Hindu Business Line : Will India skid on oil prices?

In the face of hardening crude oil prices one would have expected officials in North Block to be worried about the adverse impact on the economy. On the face of it, spikes in crude prices and the import bill could put paid to the promise the economy held out — of repeating last year's robust GDP growth. At $72 a barrel, oil prices may have dropped from their intra-week high of $75 but the chances of a further fall are indeed slim since the factors contributing to the hike show little signs of changing. On the contrary, the instability in some major oil-producing countries, the strong global economic revival and expanding demand are likely to tighten supplies and raise prices. Under the circumstances, the response from vulnerable developing economies such as India has been surprisingly self-confident.

The Finance Minister, Mr P. Chidambaram, recently admitted that the crude prices were worrying but did not think they would impact GDP growth. He did add that they could stoke inflation. One would have thought that the major cause for worry the world over is the impact of high oil prices on inflation because an undue rise in overall prices could lead to a drop in demand and, therefore, production, thereby impacting the real economy. But the Finance Minister's reaction to the oil price spurts is of a piece with world thinking; unlike in the 1970s, the response to global firming of oil is not one of alarm now. The main cause for this is that despite oil prices doubling since 2003, world GDP growth averaged 4.8 per cent in 2005, well above the long-term average of around 3 per cent and is expected to sustain the momentum in 2006 and 2007. The world economy appears to have become more resilient to oil price hikes and able to absorb shocks. But is the Indian economy strong enough to absorb future rise in oil prices, inevitable as they are?

So far the Indian economy has withstood the shocks by simply being protected from them, courtesy the subsidies that have kept fuel prices low. But how much longer can that luxury be sustained without bleeding the oil companies, or widening the fiscal deficit beyond repair? Sooner than later the economy will have to face the cost of high oil given the improbability of domestic supplies filling demand gaps enough to sustain growth. Even in January-March 2006, the average price of the Indian basket of crude varieties was 30 per cent higher than it was a year ago; mineral oils accounted for 13.2 per cent of inflation. Should oil subsides be lowered, will the economy be able to absorb the price shocks and grow at projected rates? It would require a tremendous effort, even perhaps a re-working of the `India Story', to sustain the pace.

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