Crude oil prices are boiling again. This time, it is the Iran issue which is sending tremors down the global economy. Unfortunately, the Indian economy is highly sensitive to crude prices which seem to be more inflammable than the crude oil itself. Recently, global crude prices touched three and a half year high on news of pipeline explosion in Saudi Arabia that turned out to be a hoax. With already around 80% reliance on imports, what spells huge trouble for India is the fact that post China; it is the second largest importer of Iranian crude. If supplies from Iran go off market, India will be amongst the first and worst hit victims. The shock will not just be on the supply front. It means higher subsidies, thus raising the fiscal deficit, weakening domestic currency and rise in inflation. Such a situation will only lead to vicious circle. Even if fuel prices are raised to cut down the subsidy bill, it will lead to direct inflation leaving us with no growth prospects. Once oil prices go on an upswing, a fall would be hard to see on account of growing global liquidity.
Increasing crude prices and depreciating rupee is an explosive mixture than can hurt the Indian economy. Unfortunately, there seems to be no policy solution to it. In a regulated price scenario for majority of the petroleum products, the fuel prices are bound to see an upward revision as subsidy costs keep increasing. Under the current circumstances, it will be really tough for the country's policymakers to stick by inflation targets without taking a severe hit on growth.
To summarize, it won't be an exaggeration to consider high crude prices a bigger threat to global economy than the defaulting European economies as the former has wider ramifications and is quicker in its spread. The high oil prices will be a key determinant of economic policies. As inflation seems to be unavoidable in a rising crude price scenario, India will be affected both on the trade deficit and subsidy front; the latter having already led to a ballooning fiscal deficit.