Oil prices edged close to $100 this week again. At the last meeting of the OPEC in September the fear was that prices would fall. But in just nine weeks prices had shot up 26 per cent. Apparently, the balance between demand and supply is too unstable though the International Energy Agency has marked down world demand for oil at the current high price.
Chances however are that a $90+ price is likely to be the trend for the future.
An increase in the price of oil brings about a transfer of wealth from oil importers to oil exporters. In the past five years, the oil importers have been earning an additional $700 billion a year. That is about 1.5 per cent of the world GDP. The repercussions of such a huge redistribution of world income are bound to be serious.
There are three major outcomes of an oil price increase. First, with the increase in the expenditure on oil people have less money to spend on consumption of other products. That pulls down growth. Second, the increase in the price of petroleum products, particularly petrol and diesel, kicks up inflation and consequently interest rates. Third, the imbalance in external payments position hits currency exchange rates.
Obviously, countries that depend more on import of oil will be hit harder. The biggest importer is the US which is already burdened with sub-prime mortgage crisis and slump in construction activity. The increase in oil prices will further eat into consumption and hasten the run into recession.
The European Commission has estimated that growth in the 27-nation EU will decelerate from 2.9 to 2.4 per cent.
Inflation has already scaled up to 2.6 per cent and is set to increase in the next two quarters. It may settle down at 2 per cent by mid 2008. It is possible that with the increase in inflation the ECB will raise interest rate.
Japan is the second largest importer of oil though its current imports are less than in 1973. Currently, its economy has been bordering on zero growth and the increase in the price of oil and depreciation of currency will force the economy into the negative zone.
The other major oil importers are China, India and South Korea which will also suffer deceleration. The price of petroleum products in India has been subsidized and pending elections may not be increased. That does not stop the adverse impact of oil prices. For, the subsidy will have to come out of the budget and, instead of the drop in private consumption, it will be the fall in Government investment which will cut into growth.
Oil importers have about two-thirds share in the world economy. With the redistribution of incomes from oil prices their growth will be down 0.5 per cent. That is quite a heavy price to pay particularly for the emerging market economies like India'a that have yet to settle into a firm growth orbit.
The writer is president, RPG Foundation