Crude oil prices are moving towards the $100 mark. Should we be worried?
It is not easy to assess the impact of an oil shock on an economy. That task still remains an art. In spite of two oil shocks in 1973 and 1979, it is still unclear how to make good quantitative assessments of the phenomenon.
The United Nations Development Programme (UNDP) has tried to come to grips with this problem in a recent report, Overcoming Vulnerability to Rising Oil Prices: Options for Asia and the Pacific. It has created an innovative Oil Price Vulnerability Index (OPVI) to measure the impact of oil price hikes on countries in Asia and the Pacific.
The index is a composite of three factors: economic strength of a country, its economic performance and economic growth with a low share of oil in its energy mix.
The results are interesting for India. The index is a good reflection of the muddled state of energy affairs that prevail in the country. India ranks at a comfortable No. 5 among 24 nations (the greater the number rank of a country in the OPVI, the more vulnerable it is). Its use of coal and hydro power to generate energy have been highlighted in the report; this is reflected in the economic growth with a low share of oil part of the index.
Probably this is where the good news ends, at least on the policy front. With increasing oil imports (as measured by the gap between domestic oil production and consumption), India’s economy is much more vulnerable to exogenous shocks. For India, the gap in 2006 stood at 2,500 barrels a day.
Fuel price distortions are only prolonging the inevitable, if painful, recalibration of prices. They have also badly dented the country’s capacity to bear the brunt of upward oil price swings. This is measured by the economic strength variables in the OPVI. These, as structured in the index, take stock of major indicators like the balance of payments, the current account situation, budget balance and oil import dependence. Here India takes a beating. The economic strength indicator is -0.03 for India (compared with China’s 0.87) and India ranks at 11 out of the 24 countries in question. In this respect it is the weakest among the major economies of the region.
The lessons for India are clear, even if the road map to implement them is not. Any fuel price hike in line with economic costs of production and delivery threatens the government of the day through inflation and consumer anger. But not correcting prices would be perilous to longer-term economic security. There’s no gainsaying that subsidized fuel costs hide the true costs of production of manufactured goods. Post-price correction, profits would be illusory for a large number of producers. All this is well known, but the cost of business as usual is not.
These matters have been stressed and highlighted so many times that people have come to believe they represent a false alarm. This is not true. The innovative, off-balance sheet accounting of oil costs hides the real costs of oil in India. If these were to be accounted properly, India’s ranking in the OVPI is sure to deteriorate. This would, mainly, be the result of a fall in the economic strength component of the index. The interplay between macroeconomic performance and policy myopia is captured well by this component. It would be interesting to watch this over time.
The problem then is to balance short-term comforts with longer-term security. There are questions whether the political system can make these adjustments, for the policymaking and implementing apparatus cannot do so without political initiative. For this, ultimately, citizens have to be informed about what is possible and what is not. They have to decide whether they want the pain injection at one time or spread over time.
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