Photo: Reuters
Photo: Reuters

The good and the bad of the oil price slump

While India will cheer that lower crude prices will ease some of the inflationary pressures, it should worry about shrinking global demand

Last week, international crude oil prices touched a new low. Brent crude, the global benchmark, dropped to $61.85 per barrel on Friday—the lowest in the last five years. The fall has been precipitous in the last six months. From mid-June, Brent crude has declined by nearly 50%. And this is exactly why the initial cheer that accompanied the southward trajectory of oil prices is rapidly giving way to concern.

Not only is the virtual free fall of international crude prices a point of concern, equally, if not more, worrying are the reasons underlying this fall. After all, crude oil is a bellwether of larger global trends. Yes, there is a situation of excess supply after the US increased production through domestic fracking. While this is the case, it is obvious that the real problem is of declining global demand for crude oil. Exactly the reason as to why the global commodity supercycle too has ended. Obvious then that there are several lessons to draw from this.

First off, the implications for the global economy. Even as the Chinese juggernaut slows (and may even well come off the rails), the European Union stares at the spectre of a recession and Abenomics seems to have run its course in Japan. Barring the US and to a degree India, no other region in the world is projecting a positive outlook. Obviously, the prognosis for the global economy is far from rosy; in fact, the concern is that if unchecked, the world economy may be looking at a recession of the devastating magnitude witnessed in the 1930s.

Second, flowing from the above, this trend threatens a geostrategic impact. Nations heavily dependent on commodity exports are particularly vulnerable. Not only are the prices of their products declining, but demand too is drying up—in turn reinforcing the downward pressure on commodity prices. Exactly why countries such as Australia, Russia and Venezuela are seeking new pastures, including courting countries like India that are looking to revive their economy. An economically weaker China will put the brakes on the country’s global designs, but may make them more belligerent as frustration begins to take root. The other side of this coin is that this will strengthen the hand of the US.

Third, related to the above, it is obvious that the ecosystem that evolved around the previous bull run in international oil prices will take a hit. Both downstream and upstream industries should brace for some bad times. If the current situation deteriorates into a global recession, then this phase is likely to be long and trigger layoffs and a cutback in investments.

Fourthly, for countries like India, it is both good and bad news. The trade-off between growth and low commodity prices is rapidly skewing. So while India will cheer that lower crude prices will ease some of the inflationary pressures, it should worry about shrinking global demand.

Both are already manifesting in the latest macroeconomic data. While retail inflation continues to decelerate, declining global demand has impacted exports—even while imports, led by gold, continued to grow. As a result, the country’s current account deficit widened to a five-quarter high of 2.1% of gross domestic product (GDP) in the second quarter ended 30 September. In the preceding quarter, it was 1.7% of GDP. Exports in the September quarter slowed to 4.9% from 11.9% during the same quarter a year ago, while merchandise imports increased 8.1% against a decline of 4.8% the second quarter of 2013-14, largely due to a sharp rise in gold imports—more than offsetting the impact of a decline in the oil import bill. Net gold imports increased to $7.6 billion in the second quarter from $7 billion in the previous quarter.

A lot on how the pros and cons play out will depend upon what the incumbent Bharatiya Janata Party-led National Democratic Alliance (NDA) dishes out in the forthcoming Union budget—its second in less than nine months. It has spent the first few months of its tenure in cleaning up processes—the gains from which are largely intangible. It is now time for the NDA to change gears; the growing downside risk from a global recession only makes it that much more urgent.

It is then clear that the plunge in international crude oil prices is forcing tectonic shifts in the global economy. In otherwise turbulent times, the implications of this setback are not only graver, but, worse, very unpredictable.

Anil Padmanabhan is deputy managing editor of Mint and writes every week on the intersection of politics and economics. Comments are welcome at capitalcalculus@livemint.com.

Close