Impact of crude oil prices on Indian Economy since 1971-2005 by Mohammad Rafee

Impact of crude oil prices on Indian Economy since 1971-2005 by Mohammad Rafee

India is the 7th largest country with the land mass of 3.29 million sq.k.m and second largest in population of over one billion. It accounts for 16 percent of the world population. The country has to produce about one trillion worth of GDP to fulfill the needs of its huge population.

In order to produce this one trillion dollar worth of output, India needs 2.5 million of oil per day which is 6.5 percent of total world demand for oil. The share of commercial energy consumption in total energy consumption has increased from 29 percent in 1953-54 to 68.2 percent in 2001-02. These ever exert demand profound influence on the growth and inflation levels in India.

International oil price assumed to affect the domestic prices. However in India’s case the sharp increase in international oil prices has not been fully transmitted in to the domestic prices. The administrative price mechanism had shielded the country from the impact of oil shocks. Now the govt of India has given up the administrated price mechanism in oil sector and linked the domestic oil prices with international oil prices. Oil price is certainly as external factor how it affects the Indian economy. This made me to undertake this research work.

Statement of the problem :- international oil price how it affects whole sale price index of India, exchange rage or rupee to dollar, growth rate of India, forex reserves of India, oil and non-oil trade balance.

Objective of the study:-

• To analyse trend in oil price
• To study the relationship between oil prices & inflation, exchange rate of rupee to dollar, growth rate of India, forex reserves of India, oil & non-oil trade balance.
• To offer policy suggestions.

Hypothesis’:- * there is no difference between explanatory powers of international oil prices per barrel in dollar & annual percentage change in international oil price variation in explaining the change in the selected macro economic impacting variables.

Methodology:- the study relies exclusively on secondary data, pertaining to international oil price, growth rate of India, exchange rate of India, forex reserves of India, inflation & oil and non-oil trade balance. The data of oil downloaded from forbes.com. Data related to other variables were downloaded from RBI website.

Tools used:- annual percentage change has been calculated to analyse the trend behavior. Multiple linear regression models has been fitted to assess the impact of oil prices on the selected variables.

Limitations:-

• The impact has been assumed with regard to the selected variables alone. So the impact assessment would be partial. Because oil prices can penetrate all the sectors of the economy.
• The public sector oil companies and consumers have shared the burden of oil price increase. Public sector companies, backed by the government support. Ultimate burden shifted to people whole in the form of taxes.

Significance of the study: - Energy is the driver of economic growth. Energy from the oil is the largest source of energy supply. However significance of the oil prices has not been put into through explanation. A study that addresses the nuances of consequences of oil prices hike may guide government of world countries in policy formulation.

Period of study:-

From 1971-72 to 2005 on the study period there was energy crisis in 1973 and in 1979 and a gulf war in 1990. In 1991 India started its reforms Liberalization, privatization & globalization. These are all the major causes to undertake the study on oil prices.

About crude oil:-

Crude oil is a naturally occurring liquid composed mostly of hydrogen and carbon. It is believed to have been formed from very small plants & animals that lived in ancient seas and oceans a very long time ago. As these plants and animals die, they sink to the bottom of the sea. When thy mix with mud, sand and clay.

This mixture of mud & organic (once living) material is rich in hydrogen & carbon. Over millions of years this layer of organic rich mud becomes buried thousands of feet deep in the earth.

The temperature of the earth becomes hotter as you go deeper in to the earth. The combination of increasing temperature & pressure on the organic mixture causes change in to crude oil. If the temperature increases further crude oil can be changed in to natural gas.

Crude oil prices:

Inflation firmed up in the second half of 2005 in a no. of economies with a movement in international crude oil prices with oil price reaching record high of us $ 70.88 $ a barrel in august 2005. With that advanced countries like US, UK & European Union experienced inflation at the rate of 4.7, 2.6, and 2.5 respectively.

Crude oil price rose to US $ 70.88 a barrel on august 30, 2005 in the immediate after math of hurricane Katrina. Prices in the subsequent months moderated to below US $ 60 a barrel during November-December 2005. Reflected supply augmenting efforts by the IEA and the OPEC slowing of oil demand growth and a relative warmer weather in the US. But prices again edged up to US $ 67-68 a barrel in Jan 2006 on disruption of Russian Natural gas deliveries to Ukraine threatened supplies to Western Europe, unrest in Nigeria and tension over Iran’s Nuclear Programme.

OPEC:-

Organization of Petroliam exporting countries. Members include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, and UAE & Venezuela. OPEC was found in Baghdad, Iraq in Sep 1960.

Oil Crisis:-

Price increase of 2004-06 oil price was $ 25 per barrel in sep 2003.but by august 11, 2005 it had rises to over $60 per barrel & a record price of $ 78.40 per barrel on July 14, 2006. Experts attributed spike in prices to a variety of factors, including North Korea’s missile launches, the crisis between Israel & Lebanon, Iranian Nuclear programme & US department showing a decline in petroleum reserves.

Testing of Hypothesis:-

** There is no difference between explanatory powers of international oil prices per barrel in dollar & annual percent change variation in oil price in explaining the change in the selected variables.

In the analysis the relationship between the oil price variation & selected variables has been showing a negative relationship. Therefore the Null hypothesis is rejected.

Findings:-

There is no significant relationship between inflation & oil prices. International oil price behaved more erratically in 1980’s. While inflation was erratic in 1970’s.

Similar behavior is found in case of inflation. The volatility of exchange rate behavior has intensified during the study period. The variance of dollar- rupee exchange rate of 1980’s is higher than 1970’s and in 1990’s.how ever the regression results suggests that international oil prices is not a significant variable in determining the exchange rate of rupee.

Growth rate of India had fluctuated in 1960’s and in 1980’s. The growth rate was stabilized and in 1990’s there was further decline in ups and downs in growth rate of Indian economy as shown in the variance.

There is seemed to prevail negative relation ship between annual percentages in oil price the growth rate reduced to 0.1 percentages.

Every unit increase in annual percentage change of international oil price can deplete 63 million of forex reserves.

The oil price is not significant variable in explaining the change in non oil trade balance of India. Every increase in oil price in dollar the non oil trade balances may be widened by 68 million dollars. Similar with every increase in oil price. The non oil trade balance may be widened by 5.60 percent.

The oil trade balance of India may widened by 12.13 percent with every unit increase in oil prices.

India lost 17.95 percent of trade balance every year during the study period with every percentage increase in international oil prices.

Conclusion:-

The study concludes that international oil price does not affect the domestic prices of a country significantly. Similarly the oil prices do not exert a strong influence on the economic growth of India. Quantity of possessions of forex reserves the exchange rate of rupee in dollar terms and trade balances.

The multiple regression co-efficient of determination R2 in the case of above variables is worked found meager 10 percent of the variation in all the above macro economic impacted variables.