- As India depends on imported crude oil, global trends have a big impact.
- Crude Oil prices fell sharply yesterday on disappointing economic data & as signs of a slowdown in China and Europe reinforced worries about weakening demand for petroleum.
Why are crude oil prices falling now?
- Prices have swayed from above $160 per barrel in June 2008 to about $35 in January 2016.
- The recent fall has been attributed to two main factors:
- Higher supply and volatility due to uncertainty about the global economy.
- Fears of the consequences of a full-fledged trade war between the S. and China have rattled speculators.
- Key support factors for oil price would be anticipated production cuts as well as U.S. sanctions against Iran.
- Also, automobile demand has risen globally, and as internal combustion engines still rule the roost, demand for oil is not expected to plummet yet.
What’s the Indian basket of crude?
- It is the weighted average of Dubai and Oman (sour) and Brent (sweet) crude.
- It’s the indicator of the price of crude imports for India and the index has a bearing on price rise in the country.
- The price of the Indian basket averaged at almost $70 for April 2018 and had risen to breach $80 in October 2018.
How do fuel prices influence inflation?
Historically, oil price swings and inflation have been positively correlated, even though this relationship has varied widely across countries.
- Prices of goods are determined as much by their supply as by the cost of transportation.
- Rise in fuel costs are passed on by truck fleet owners down the chain to consumers.
- Accelerating inflation influences the central bank to raise rates thereby making it costlier to borrow.
- Higher interest rates keep supply of money in check and hence control inflation.
What factors influence crude oil price?
- Global demand for oil.
- Decisions by major producing nations to raise/ cut supplies and
- The global political environment are the key reasons to oil prices.
- Falling oil prices often affect activity and inflation by shifting aggregate demand and supply and triggering policy responses.
- On the supply side, lower oil prices lead to a decline in the cost of production.
- The lower cost of production across a whole range of energy-intensive goods may be passed on to consumers and hence, indirectly, reduces inflation.
- The lower cost of production can also translate in higher investment. On the demand side, by reducing energy bills, a decline in oil prices raises consumers’ real income and leads to an increase in consumption.
How does crude oil price affect the rupee?
- India imports more than 80% of its crude oil requirements, and it has to pay for these imports in foreign currency, mainly dollars.
- If international crude prices rise, refiners in the country need to spend more in dollars.
- If there is volatility and uncertainty about which way prices will sway, refiners tend to buy more oil and stock up.
- As rupees are exchanged for the U.S. currency in this exercise, it generates a demand for the dollar, thereby weakening the rupee.
- On October 1st, 2018, the Indian basket price was $82, and the rupee rate was 72.8 to a dollar. By November 20th, 2018, the Indian basket had eased to $64.8 and the rupee, almost in tandem, strengthened to 71.3.
- The recent decline in oil prices will have significant macroeconomic implications.
- If sustained, it will support global growth and disinflation.
- It will also trigger significant real income shifts from oil exporters to oil importers, strengthening growth and reducing inflation in many oil- importing countries but dampening economic activity in oil-exporting countries.