Depression talk and the Oil pool account - Views on News from Equitymaster

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Depression talk and the Oil pool account

Sep 13, 1999

'Depression' is much talked about these days. But not because of its threat. As recent as last year, the Economist, a leading weekly publication, had carried a cover feature on the threat of deflation that several economies were facing, and how the world was generally engulfed in an environment of falling prices. This view was supported by none other than Paul Krugman, a leading economist, who went on to title his latest publication 'The Return of Depression Economics'.

According to the Asian Development Report 1998-99, the average commodity prices declined by 25% during 1998. It went on to report that commodity prices, in real terms, were at an all time low since the early 1970s. Crude oil, which as recently as 1997 was trading at US$ 23 a barrel, had come crashing to under US$ 10 levels. Even though there was gloom all over, oil-importing countries benefited from lower import bills.

India, of course, was one of the beneficiaries, given its large dependence on oil imports. Now, with the oil prices having bounced back to US$ 23 per barrel, the Indian government has once again started to feel the pinch. The oil pool deficit account has ballooned to Rs 50 bn over the past couple of months. As there is little hope that oil prices will retreat to lower levels, the Indian government will have to take measures to rationalise the prices of petroleum products. This is expected to result in an across the board price hike, which will create inflationary pressures in the economy. Moreover, given the not-so-strong recovery in domestic demand, Indian companies would have to absorb a large part of the increase in costs. This will adversely affect margins and reduce overall profitability.

The solution to India's problems lies in the reduction, and gradual eradication, of subsidies and the subsequent decontrol of prices of petroleum products. While the former will remove the burden of subsidies on the oil pool account, the latter will ensure that prices move in sync with global trends. These steps will go a long way in improving the financial position of the government and the competitiveness of the Indian industry, which hitherto had been protected by relatively stable prices. Moreover, a more determined effort should be made to develop the oil exploration industry, which could reduce India's dependence on foreign countries to meet its domestic requirements.

Until then, the only hope for the oil pool account is another depression like situation.

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