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

• The CAD to GDP ratio will rise sharply irrespective of a higher GDP growth; and a 10 USD/barrel increase in oil price will raise the inflation by roughly 49 basis points (bps) or increase the fiscal deficit by 43 bps (as a percentage of GDP).

• If the government decides to absorb the entire oil price shock rather than passing it to the end users, noted a RBI research paper.

• The crude price shock in the 1970s sent many economies tumbling down for almost a decade.

Key highlights mentioned in the studies

• The study looks at the quantitative impact of crude price shock on India’s three major macro-stability indicators: current account deficit (CAD), inflation and fiscal deficit.

• The paper has presented broad results on the impact of oil price shock on the Indian economy from an accounting perspective.

• On the external side, India will remain vulnerable to such shocks due to its high import dependence.

• This vulnerability can lead to episodes of sharp increase in CAD and rising GDP growth would be insufficient to counter it.

• On the domestic front, such episodes will lead to surge in inflation or fiscal deficit or both, depending on how much of the increased prices the fiscal authority decides to pass-through.

• The increase in fiscal deficit can have a secondary impact on inflation over the medium to long run.

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Mains Paper 3: Economy

Prelims level: Crude Price Shock

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