Slick populism

Oil at $100 a barrel was seen as an impossibility just a decade ago. When oil prices started to move beyond $40 a barrel mark some years ago, analysts had raised the bogey of a serious global economic crisis if the price of crude inched closer to $100 per barrel. This was generally discussed by experts as a merely theoretical possibility. Soaring oil prices would cause hyper-inflation, which in turn would result in a major economic downturn. Of course, none of this has happened.

The macro economic impact of high oil prices continues to baffle economists used to seeing economic behaviour through a certain pre-determined theoretical prism. It is also true that developments in the global economy in the last six to seven years have defied many received notions of economic behaviour. The great growth story in the emerging economies, it seems, has created enough of a productivity cushion to absorb crude prices at $100 a barrel. In real terms, that is, after accounting for inflation in the intervening years, oil price today is close to what it was during the oil shock of the seventies. There is no crisis this time round because oil price increase is led by robust growth and productivity globally. This is borne out by the fact that average inflation rate across the world is less than 5 per cent. There is hardly any economy of consequence with a double digit inflation rate today.

However, it cannot be said with certainty that if oil prices continue to rise at this rate there would be no adverse impact on the world economy. There is no room for complacency. In India’s case particularly, the inflation rate does not reflect in the actual international price of oil. The retail prices of diesel and petrol were last aligned with international prices when crude was at $58 a barrel. At today’s crude price, under-recoveries of oil companies could be over Rs 71,000 crore in 2007-08. This is clearly a hidden fiscal cost for the government. If the Centre pays oil bonds to the public sector oil companies to the tune of Rs 30,000 crore, it works out to nearly 1 per cent of GDP. This fiscal cost is outside the government’s balance sheet, but carries all the effects of higher fiscal deficit. It is time the government took correctives, even if political signals coming from successive state elections suggest otherwise.