Sep 8, 2000|
Economic turmoil on the horizon?
Well, this is not exactly an overstatement. Maybe a little overboard but once one considers the fallout of certain international developments on the economy, things do start to look gloomy. Not that we are pessimistic about the economy's resilience. Just that it is difficult to believe (and history supports this) that our politicians will be able to come out with policies to effectively tackle this issue.
The international development we are referring to is the surge in crude oil prices, currently at levels reached during the Gulf war. The government, so far, and expectedly, has failed to take effective measures to curb the fallouts of this development. We look at the two primary effects of rising crude prices, which will almost certainly have implications for each and every segment of the Indian economy.
The first is inflation. Higher crude prices imply higher price of finished products like diesel, petrol and kerosene. In Indian however finished product prices have failed to move in sync with crude prices largely due to a mechanism that absorbs the effect of these price variations. This system is known as the Oil Pool Account. As prices have tended to move only one way, there has been an accumulation of a large deficit in the oil pool account. The deficit continues to grow as the government has failed to raise the administered prices of finished products.
Now, however, it is increasingly clear that prices need to be raised (the extent of the rise may be still lower than what is necessary). And as oil products serve as key consumption and feedstock materials, the effect of the price rise will be felt in most commodity/product prices. And given the fact that Indian companies are just coming out of a slowdown, it is unlikely that they will be in a position to absorb the inflation in costs. Inflation, which has already increased significantly over the last seven months, will once again get a boost. Higher inflation, needless to say, will have adverse implications for the entire economy.
The other adverse development that is likely to be triggered by rising crude prices is an enlarging of India's trade deficit. Last year, India imported over US$ 10 bn worth of oil at an average price of US$ 18. This year imports are likely to be even higher at US$ 16 bn. Although exports have been rising, and at the current account level software exports will provide a cushion, fallout in terms of volatility in the forex markets cannot be ruled out (depreciation in the value of the Rupee will again have implications for inflation). Such developments, as witnessed in the past, could lead the government to take decisions, which may not be in the best interests of the business sector.
There is also a need to highlight a third factor, which has been triggered by the government's indecision regarding tackling higher crude prices. This refers to the deficit in the oil pool account. The fiscal wizardry adopted by past governments ensured that this deficit does not reflect in the national accounts. It is ‘off balance sheet’. Nevertheless the deficit needs to be met by either raising prices or by finding ingenious ways of transferring funds from the national accounts to the oil pool account. Either way, the effects are likely to be adverse, as it is the end consumer that is likely to suffer (someone needs to ask what happened to the government's plans of raising domestic crude output!).
The stock markets seem to have ignored the fallout higher prices on the economy for now. However, if the rise in crude prices sustains, one can expect some hard decisions. Then maybe it will be difficult to ignore this potentially turmoil inflicting development.
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