Literature Review
It is found that oil prices have undergone critical decline over past couple of years for several reasons at the bottom of this decline. However, reducing demand triggered by increased production of oil in USA, over production by OPEC, and shift towards renewable sources of energy is considered the most fundamental reason behind current downtrend of oil prices. It conforms to the simple theory of demand and supply according to which demand and price are in positive, while price and supply are in negative relationship with each other (Stafford, 2015; Scott, 2015; Goldenberg, 2016; Arnold, 2008; Hensher, Rose, & Greene, 2005; Hoag & Hoag, 2006; Arnold, 2008; Hensher, Rose, & Greene, 2005; Hoag & Hoag, 2006). This section covers theoretical and conceptual discussion on the case of the study focusing mainly on quantitative data.
1.1. Macroeconomic Impact of Declining Oil Prices on Oil Importing Nations
In the light of economic theory dealing with underlying case, it is well in place to state that declining prices of fossil fuels are positive indication for oil importers. As a matter of fact, oil importing countries import oil to address their energy requirements. When oil price is declining, its first and direct impact is that they have to pay less to purchase the same from the international market. Hence, the money saved in this way can be spent on projects on a public level. In this way, the government can best pass the economic impact of declining prices onto public (Husain et al., 2015; Silverstein, 2015).
Figure 4 - Inverse Relation between Oil Price and Economy of Oil Importers this picture should be removed
(Image retrieved from http://www.lifehack.org/articles/productivity/10-simple-ways-to-find-balance-and-get-your-life-back.html)
It simply implies that as the prices of oil plunge, they have a positive effect on the economic indicators of oil importing nations as also shown in Figure 4.
Bowler (2015) also supports these opinions and opines that oil importing countries are the real winner in the scenario of declining oil prices. He argues that oil importing nations simply have to pay less to address their energy requirement that will be a gain both on the national and individual level. When people cut spending on any commodity, it boosts their purchasing power. In other words, fall in crude oil prices means purchasing power of people in oil importing countries to grow (United Nations, 2007; World Bank Group, 2015; Devarajan & Devarajan, 2015).
It is also important to note that fossil fuel prices are closely interlinked with the inflation rate in an oil importing country (as also shown in the figure below). For example, crude oil is used in almost all types of production industries in factories and shipping. Therefore, oil prices are in direct relationship with their production and operational expenses. It implies that as a result of an increase in oil prices, companies will have to increase the prices of goods in order to cover the increase in total cost. Similarly, the decline in oil prices allows companies to pass its benefit onto consumers by lowering the prices resulting in reduced level of inflation (Galbraith & Berner, 2001; Hunt, Isard, Laxton, & International Monetary Fund, 2001; Mehra, 2008). It is also illustrated through the diagram provided below that deals with the data relating to inflation rate in the UK and its response to changes in oil prices:
Figure 5 - Oil Price and Inflation Rate in the UK
(Duncan, 2015)
In addition to this, falling oil prices also have a significant impact on the annual budget of oil importing nations. Oil importers rely largely on oil import for their energy requirement. In this way, funds allocated for energy needs account for a high share of the budget. Dropping oil prices make it cheaper, and government can get benefit from this opportunity. As a result of it, most of oil importing countries enjoy comparatively less budget deficit (or even budget surplus) due to declining oil prices (Monetary Policy Report, 2015; Giles, 2014). For example, budget deficit of Japan has reduced to -7.1 as of 2016 that was exceeding -8 in 2012 (The China Post, 2015).
However, there are also some contradictory opinions when it comes to that. Some analysts have altogether different take on the matter and are of the view that falling oil prices hardly have any positive outcomes in the long run for oil importing as well as oil exporting nations. World Bank (2015) also advocate the similar kind of idea and present the following diagram to assess the impact of oil prices on oil importing countries:
Figure 6 - Impact of Falling Oil Prices
(World Bank, 2015)
World Bank (2015) also provides theoretical insight into the base of this negative effect. The author argues that the idea of the positive impact of declining oil prices on oil importers is based on a misconception. It is seemingly so, but there is much to be taken into account at its depth that makes the scenario different. For example, the effect of decreasing inflation is offset due to decline in interest rates and currency depreciation that can lead to long term negative implications for the economy and cannot be considered optimistic indication in any case. Demand for currency declines during deflation that causes interest rates to come down. In the wake of declining interest rates, foreign investors lose their interest due to which currency is depreciated (World Bank, 2015).
1.2. Macroeconomic Impact of Declining Oil Prices on India
India is one of the top importers of crude oil around the globe. Rapid economic growth of India is boosting the trends of industrialization. More and more manufacturing plants are being set up every day, and rising population has also increased the rush of traffic on roads (causing the increase in demand for fuel). All these facts together have made it the 3rd largest importer of oil in the world (Egan, and Riley, 2016).
Gross domestic product or GDP in short is considered one of the strongest economic indicators for any country. For example, when economy grows, it serves as boon to the business sector. Furthermore, the growth of business in the region creates an atmosphere of competition. All macroeconomic factors interrelated to one another accelerate under the impact of this developing scenario. For example, establishment of new business entities increases demand for labor due to which equilibrium in the labor market shifts to high level of demand and wages. Due to high wages, demand for products and services grows that provide rationale to business to increase focus on production in order to stay aligned with growing trends of consumption. Therefore, declining oil prices are theoretically in positive relationship with gross domestic production of any economy (Mehra, 2008).
Indian GDP has also shifted its direction from decline to growth since the current downfall of oil prices initiated. A short term trend of growth in GDP along with forecast for next few years is provided in the diagram below:
(Statistia, 2016)
The figure shows that GDP, after being hit hard by recession has gone through long phase of decline till it reached its lowest i.e. 5.62% within several years in 2012. Then, its revival started since it began to show the signs of improvements in 2013. As of 2015, it was recorded at 6.34% and is expected to grow gradually and steadily by the end of 2020. There can be several factors at the bottom of the comeback made by India in terms of GDP growth; still, it is interesting to observe short term fluctuations in comparison to the changes in oil prices.
Change in the budget deficit over a period of time is one of the key matrices to evaluate the economic growth of any country. For example, when a country is exceeding its targets determined in the budget, it will enjoy decreased budget deficit or increased budget surplus that is indicative of betterment in overall economic posture of the country. Contrary to that, increasing deficit or decreasing surplus suggest negative gap between budget targets and actual outcomes (Oosterbaan, Ruyter, Windt, & N, 2000; Barro, 1998; Lim, 2014; Noell, 2013). Therefore, it is appropriate to the objectives of the study to have a look at the changes in the budget deficit of India over the period of time that is characterized by declining oil prices. It is shown in the figure provided below:
Figure 7 - Budget Deficit Reduction for India since 2012 in India ?
(PTI, 2016)
As shown in the Figure 7, Indian budget deficit is on consistent decline in the wake of falling oil prices. It is important to note that Indian government has decided to cut its oil subsidy by 4%, which also adds to current account balance. The government has already applied a subsidy of more than 50% for 2014-2015 on petroleum products. For example, oil subsidy was cut down from a level of INR. 6027 million to INR. 3000 million (PTI, 2016). The deficit was as high as 4.9 as of 2012 and 2013, and has come down to 3.5 in 2016 exceeding the estimated level shown in the figure above. That is why the government is optimistic about its future (Verma, 2016).
It is also interesting to note that inflation rate is consistently declining under the impact of declining oil prices. Declining oil prices in the local market negatively affect the prices of other goods and commodities due to decreasing expenses on shipment and manufacturing. These declining prices create an atmosphere of deflation or slowing inflation. Impact of declining oil prices on Indian economy is illustrated through the diagram provided below:
Figure 9 - Inflation Rate in India since 2011
(Trading Economics, 2016b)
However, World Bank (2015), shows that the decline in oil prices is not necessarily an optimistic indication for economy when it comes to its impact on inflation. As discussed earlier, deflation makes the environment unfavorable for business and investment. As a result, its interest rates suffer decline. Due to low interest rates, foreign investors hesitate to make investments, which imply that declining oil prices can be hurdle to foreign investment. Hence, ultimate scenario leads to the depreciation of currency that largely offset the apparent benefits of declining oil prices (World Bank, 2015). Practical application of this theoretical idea is displayed in the graph provided as under:
Figure 10 - Declining Indian Currency
(XE, 2016)
In 2016, one Indian rupee is being traded for $69 which is around 40% down from its strength against USD in 2012. This factor is negatively associated with the Indian economy on a macroeconomic level.
On the other hand, status of current account balance of India has shown clear signs of improvements within last five years, as deficit has undergone consistent decline with the underlying period of time. As a matter of fact, I reached its all time low in 2012 i.e. -$31857.20 million (-4.8% to total Indian GDP). However, after that, it made decent recovery year by year. As of 2016, current account balance gap of total GDP has reduced to 1.4% that was recorded to be 1.7% in previous year. It is, certainly, a positive indication for the Indian economy (Trading Economics, 2016c).
The Indian government has also decided to cut the petroleum subsidy by half (50%) from a level of INR. 6027 million to INR. 3000 million with an aim to decrease it further by 4% in 2016. The government aims to shift this subsidy to food and fertilizer sector to benefit the poor and common man. However, the policy of cutting the subsidy to this degree would not have so smoothly been implemented if oil price had not been declining in the international market. Under the cover of this decline of oil prices on a global level, the Indian government can easily proceed with this idea (Bhasker, 2015).
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