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Are falling crude prices always a positive?
Thu, 11 Dec Pre-Open

The pressure on oil prices continues with the same falling to a 5-year low of US$ 66 a barrel recently. The slide comes along with growth concerns in countries viz; Japan, Europe and China. Among other things, demand-supply ratio going below 100% is another reason.

Thus, with Brent crude down to US$ 66 or so levels, and the global supply demand dynamics moving towards oversupply, many positives are in the offing for our economy. Reduction of inflationary pressures, improving consumer spending and of course, the current account deficit will see huge improvement. Thus falling crude prices will give much needed boost to the economy. Most of us are aware of these positive impacts of falling oil prices, but there is the other side of the coin too.

We recently, came across an interesting article in Mint. As per this article, there is a positive relation between crude prices and India's real GDP growth. To support its case, the author has laid down some historical numbers, which indicate a positive trend. For instance, GDP growth declined to an average of 5.5% during FY98 and FY99. During this time, the average crude price declined 43% to US$ 12 a barrel. Similarly, the crude price declined 17.4% during FY02 to US$23.2 a barrel and the sane fiscal saw GDP growth remaining a modest 4%.

Since India is a net importer of commodities, that too with higher dependence on crude, a decline in commodity prices should result in savings in India. But there are some caveats to this. Given that the decline in global commodity prices, has high positive correlation with global crude prices, this in turn will lower growth of not only imports but also exports. Hence, the decline in current account deficit, during times of lower commodity prices might result in lower growth. Secondly, the government also loses from falling commodity prices. A decline in crude price will not only decrease the oil subsidy but, it will also reduce tax collections of the government.

Net-net, on one hand, lower oil prices are beneficial for net oil importers such as India and, as we have already seen, helps in easing off inflation. But on the other hand, as we have discussed above, it may not necessarily translate into a stronger GDP growth. Thus, it would be interesting to see how things play out going forward.

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