Oil causes trouble, again

Elevated crude prices will create complications

The international crude oil markets have been roiled by concern about supply crunches, with the price of a barrel reaching levels not seen since last year. This has come on the back of news that two dominant producers for the export market, Saudi Arabia and the Russian Federation, intend to extend their voluntary cuts in the supply of oil for three months. The Saudis have promised to reduce output by a million barrels per day, and the Russians by 300,000 barrels a day. This would keep oil supply constrained into the winter months, when energy requirements in the Northern Hemisphere typically spike. The geopolitics of the cuts — which create problems for the United States and Europe, and highlight the new closeness between the Saudis and America’s rivals like Vladimir Putin — are also worth considering.

Although prices have quickly retreated from the recent highs, analysts now expect the cost of each barrel of crude oil to go up further by the end of the year, to around $95. Some are even suggesting that prices might tip into three-digit figures. While China’s recovery is widely known to be weaker than expected, the United States’ quarters of growth show little signs of tipping over into recession. One widely viewed estimate of US growth — from one of the divisions of its central bank — considered annualised growth in that economy to be 5.6 per cent in the third quarter. The Federal Reserve as a whole may have to upgrade its estimate of US growth over the entire year. These revisions in expected energy demand will serve to support higher oil prices for the next few months. This will have an inflationary impact worldwide. The first half of 2023 saw considerably weaker oil prices than in the equivalent period of 2022, when the Russian invasion of Ukraine had sent oil prices skyrocketing. Thus, other inflationary pressures in the world economy were partially counteracted by falling oil prices. However, just as some thought the battle against inflation had ended, the rise in oil prices is likely to centre it once again.

For India, in particular as it heads into election season, this new spike in oil prices raises serious concern. India’s crude oil basket has reached almost $90 a barrel. There is a complex trade-off now between allowing fuel inflation to ripple through the economy and losing the fiscal benefits that accrue from higher fuel taxes. The second-order effect of higher fuel costs on domestic output and thus tax collection cannot be ignored either. Recent figures for the Union government’s tax revenues have been disconcerting, since they indicate a shrinkage in the Union government’s net tax revenue. While officials have insisted recently that the Budget estimates for growth, revenue, and the fiscal deficit do not need to be altered, there is little doubt that without tax buoyancy going forward, the fiscal mathematics becomes exceedingly complicated. Squeezing expenditure ahead of a general election campaign might be politically difficult, as well. The Prime Minister, in a recent interview, stressed his government’s commitment to fiscal responsibility — and that has indeed been one of the hallmarks of his administration. But with high oil prices, inflationary pressures, and stalling revenue growth, the government might face its toughest dilemmas yet.