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November 26, 2015

How Lower Oil Prices Impacted the Indian Economy

Sajjid Chinoy writes in Business Standard: "In all the discussion about India's growth performance and prospects, the elephant in the room is barely discussed." Excerpts of the article below:

 

"...India is a very large commodity importer, in general, and oil, in particular. So when oil prices collapse from $110 to $45, economic agents in India experience a large income windfall...It's easily the largest positive terms-of-trade shock that any emerging market experienced over the last year...



We estimate that almost half the windfall (0.9per cent of GDP) accrued to the government in the form of a much lower oil subsidy bill and higher oil taxes, with excise duties on petrol and diesel being almost doubled and tripled respectively. While the Centre benefitted by one per cent of GDP, states - they levy an ad valorem tax on petroleum products - are estimated to have lost about 0.1 per cent of GDP. All told, the consolidated government received a windfall of 0.9 per cent of GDP that was entirely spent...



The rest of the oil surplus - 1.2per cent of GDP - was distributed among households and firms... The first round impact on households was low - only about 0.2 per cent of GDP - given the low weight of fuel products in the Consumer Price Index, retail fuel prices not mirroring global price dynamics because of the tax hikes and many fuel products with administered prices.



Interestingly, however, the cumulative benefit to households extended much beyond lower fuel prices, because firms passed on a chunk of their benefits to households to stimulate flagging demand and retain market share...



All told, therefore, we estimate that the cumulative benefit to households was about 0.8per cent of GDP, while firms only retained about 0.4 per cent of GDP, in the wake of weak demand conditions. Most studies find that households' marginal propensity to consume in India is about 0.7, so households are expected to have spent about 0.5 per cent of GDP - which ties in with strong urban consumption over the last year. In turn, we believe most of the firm windfall has been saved, consistent with weak investment.



What does all this mean? That, of the 2.1per cent of GDP terms-of-trade windfall, about 1.3 per cent of GDP was spent, thereby boosting growth by that amount over the last four quarters, spread across two fiscal years. Over that time, India's GDP growth averaged 7.4 per cent. What this suggests is that after netting out the oil impact, underlying growth may have been closer to six per cent, reflecting the export slowdown and rural stress...



This is not meant to be alarmist. To its credit, the government has made a renewed push at reforms over the last month. But the uncomfortable reality is that growth has benefitted significantly - over a percentage point -because of the collapse in oil prices. That will soon go away, if prices stabilise. And other drivers of growth will need to quickly step up, if a slowdown is to be avoided."

 

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