Oil slick

When some analysts speculated on the $100 per barrel of crude oil several months ago, they were dismissed as doomsdayers. Most people believed that the ceiling would be reached far below that level and the world economy would eventually adjust to higher prices without much of a hiccup. While the world economy appears to have lived up to those expectations so far, the price of oil has been inching steadily higher, having crossed $75 per barrel last week. Suddenly, the $100 mark doesn't sound outlandish any more, and those doomsday forecasts are being dusted off and brought back into the spotlight. With US pump prices crossing the $3 per gallon barrier in many states a month before the summer vacation season officially begins, there is concern about the likely impact on consumer spending and, through that, on GDP growth, not just in the US but across the globe, particularly Asia. It is well-known that American consumers contribute significantly to Asian economic performance, as evidenced by the large US trade deficit with this region.

The critical issue is to understand what is driving the current spurt in oil prices, and to figure out whether current trends will continue even as oil prices climb higher. Rising demand because of relatively fast economic growth is certainly a contributor, but that has been around for some time now and cannot fully account for the recent surge. A second factor is the short-term limits on increasing supply, as a result of the lack of investment in oil during the years of low prices. Another contributor in recent days has been the evolving political scenarios in some oil-exporting countries. Iraq remains in turmoil, and the leaders of some other oil exporters, flush with petro-dollars, are flexing their muscles in various ways. Iran continues to assert its nuclear autonomy, raising fears of conflict in the region. The President of Venezuela speaks of oil policy in the context of regional solidarity. Other exporters have their own agendas or internal problems. The net result is a heightened level of uncertainty about disruption in supply from one or more of these countries, which adds a premium to the price.

The US government is worried, and reacting in a variety of ways, from considering tax rebates to consumers to offset the high prices, to imposing stricter fuel economy standards on all vehicles. Holding back on acquisition for strategic reserve purposes as well as lowering speed limits on highways are also being spoken about. The tax rebates have been dismissed by critics as trivial, but the other measures will undoubtedly have some dampening effect on demand and, consequently, prices. But, how soon and how much, are questions still up in the air.

India has reason to worry. Domestic drivers of growth, such as the automobile industry as well as transport and related services, are vulnerable to higher oil prices. Buoyant export demand, important for both GDP growth and employment, will become scarce if a global slowdown sets in. And, the stock market could take a dive if global capital reacts in unwanted ways to the changed trends in emerging markets. Much of this is outside the control of the government, so events will play out on their own. But there is the small matter of adjusting domestic retail prices to match international levels""which will rescue some of the oil companies, but cause a spike in the inflation rate. In other words, it would be wise for the country's economic managers to do some scenario-planning, looking ahead to a macro-economic situation that may not be quite as rosy as it is today.