Oil price rise is not so bad, after all
The price of crude oil in the international markets has increased by about three times since 2016. India faces a double whammy because we import 85 per cent of the oil required by us.
The price of crude oil in the international markets has increased by about three times since 2016. India faces a double whammy because we import 85 per cent of the oil required by us. This dependence threatens our economic sovereignty. Our entire economy will come to a standstill in case of stoppage of supply due to war or other disturbances. Thus, the Prime Minister had rightly said that we must reduce our dependence on imported oil to 50 per cent. The high prices of oil will lead to lower consumption and are good from this perspective. But let us first consider the harm from the high price of oil.
One major loss is that our trade deficit increases. We have to pay a higher price for our imports and need to earn more dollars to be able to make this payment. We are forced to sell our goods such as iron ore at low prices just as one has to sometimes sell her land at low prices for arranging the marriage of one's son.
The only way out for us is to reduce our consumption of oil. Towards this end we should give attention to the services sector such as cinema, music and medical transcription where the requirement of energy is less. Manufacturing requires 10 times the energy as compared to the services sector to produce the same incomes. The services sector can give us high income with less use of energy. We need to take a lesson from the United Kingdom (UK) here.
China produces $ 5.3 worth of goods and services from one kg oil. In comparison, India produces $8.2, and UK produces $16.2 worth of goods and services from the same one kg oil. The UK is able to earn more per kg oil because the share of financial, tourism and educational services is high. We too can produce $16.2 worth of goods and services, that is, twice the present production if we expand the services sector instead of manufacturing. Such an approach will reduce our need to import large quantities of oil and help contain our trade deficit
The second harm from high price of oil is that it contributes to inflation. True, but this impact should not be exaggerated. The main cause of present inflation is the growth rate of economy, not the price of oil. The rate of inflation was 3.4 per cent in 2018. It has increased by 2.8 per cent to 6.2 per cent at present. However, the growth rate of the economy has also increased in this period. The GST collections had been at a level of less than Rs 1,00,000 crore per month in 2018. These have increased to Rs 1,17,000 crore in September 2021. The economy is growing. This appears to be the main cause of inflation at the present. In comparison, the impact of the increase in price of oil is small. One estimate is that the inflation increases by one per cent due to a 100 per cent increase in the price of petrol, and by 2.5 per cent due to a 100 per cent increase in the price of diesel. The combined effect of petrol and diesel may be around 1.5 per cent. The price of petrol and diesel have increased by about 50 per cent in the last six months. The contribution of oil in the increase in inflation would, therefore, be about 0.75 per cent out of the total increase in inflation of 2.8 per cent.
The result is that inflation has been increasing more due to the increased growth rate of the economy just as bike gets overheated when speeding. The income of our people is increasing along with the growth rate hence they can bear the inflation of 0.75 per cent from their increased incomes. The harm due to inflation is cancelled by the increase in growth rate.
The third impact of the price of oil is said to be on the fiscal deficit. This is a misconception. Excise duty is collected by the Central government in terms of percentage of the price of oil. The rate at present is about 36 per cent of the price of oil. The collection of excise duty, therefore, increases along with an increase in the price of oil just as the shopkeeper gets higher commission on more expensive medicine. An excise duty of Rs 18 per liter would be collected if the price of imported petrol oil was Rs 50 per liter. An excise duty of Rs 25 will be collected if the price of imported oil increases to Rs 70 per liter. The revenue of the government actually increases and the fiscal deficit decreases along with an increase in the price of oil. Indeed, the revenue collected will be less if the Central government reduced the rates of excise duty to compensate for the increase in the international price of oil. However, this impact would be due to the reduction in the rate of excise duty, not due to the increase in the price of oil. The negative impacts of the increase in the price of oil though real are, therefore, overstated. Even these are cancelled by the other benefits derived from the increase in the price.
The first benefit is that high international price of oil is indicative of high growth rate of the world economy. This will boost our exports. Secondly, higher amounts of remittances would be sent by expatriates working in oil-exporting countries, especially West Asia. Thirdly, our energy use efficiency will improve due to the high price. We prefer to buy a bike or car that gives higher average if the price of oil is high. We may ignore the average and see other factors such as acceleration if the price of oil is less.
Thus, the high price of oil leads us to adopt energy-efficient equipment; the consumption of oil is less; oil imports are less and our economic sovereignty is protected. Global warming is also reduced. The instances of hurricanes, tsunamis, floods and droughts have increased due to global warming leading to huge economic losses. An increase in the price of oil will help reduce this negative impact. Fourthly, the solar and wind energy sectors will become more profitable. This again protects our economic sovereignty and reduces global warming. Overall, therefore, the harm can be mitigated while there are many benefits to be obtained from the high price of oil.
(The author is former Professor of Economics at IIM, Bengaluru)
(The opinions expressed in this column are those of the writer. The facts and opinions expressed here do not reflect the views of The Hans India)