The Impact of Crude Price Shock on CAD, Inflation and Fiscal Deficit

The RBI has released a paper titled ‘The Impact of Crude Price Shock on CAD, Inflation and Fiscal Deficit’. The paper outlines how the crude price shock will have an adverse impact on current account deficit (CAD), Inflation and Fiscal Deficit.

Highlights of the Research Paper

Since India is heavily dependent on oil imports for meeting its domestic demand, it remains susceptible to global crude price shocks. The research paper highlights the interrelation between the crude prices, CAD, Inflation and Fiscal Deficit as explained below:

  • An increase in crude price worsens the CAD and this adverse impact cannot be significantly contained through higher growth. Hence a crude price shock will result in high CAD to GDP ratio.
  • The crude price of USD 85/barrel in the worst case scenario will result in deficit increases by USD 106.4 billion, which is 3.61 per cent of the GDP on account of the oil shock.
  • Every increase of USD 10/barrel in crude prices leads to an additional USD 12.5 billion deficit. This is roughly 43 bps of the country’s GDP. Hence every USD 10/barrel increase in crude price will shoot up the CAD/GDP ratio by 43 bps.
  • The study states that if the price increase is passed on directly to the final consumers, it will result in increased inflation.
  • It is estimated that a USD 10/barrel increase in crude price at the price of USD 65/barrel will lead to a 49 basis points increase in headline inflation and a USD 10/barrel increase in crude price at the price of USD 55/barrel gives around a 58 bps increase in headline inflation.
  • If the government decides not to pass on the USD 10/barrel increase in crude price to customers the fiscal deficit would increase by 43 bps.

The study concludes by stating that the actual impact on the inflation and fiscal deficit will depend on the level of government intervention through changes in tax and subsidy in the domestic oil markets.

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