The linkage between the Indian economy and the global economy, always important for policymakers, has become pronounced recently. As the Modi-led NDA government embarks on some long-pending but overdue reforms in the petroleum and energy sectors, the dynamics of the global environment become particularly evident.

The decontrol of diesel prices, for long thought of but not implemented due mainly to political considerations, could be implemented at last as global oil prices took a tumble. What would normally be a controversial move became palatable as decontrol actually made retail diesel prices in India cheaper by more than Rs.3 a litre. With petrol prices having already been deregulated, the government has also rationalised the payment of LPG subsidies to the really needy.

The real test

However, the point needs to be made that if the unexpected fall in global prices has given a unique opportunity for reform, the real test for policymakers will come when oil prices move up from their present low levels. Real reform here would require them to stay away during different phases of the petroleum price cycle. Unless of course there are oil shocks that create crisis situations crying out for government interventions.

Right now, the fall in global prices has had an all-round beneficial effect in India — government finances will improve dramatically as petroleum subsidies get reduced. The fiscal deficit target of 4.1 per cent of the GDP, once considered unrealistically ambitious, looks eminently achievable now. The current account deficit will fall to the extent the oil import bill is less. This, of course, assumes that the present trends in oil and other commodity prices will hold.

Declining oil prices

After declining gradually for three months, oil prices suddenly fell by almost $4 a barrel on October 14, the biggest single-day fall in nearly a year. The Brent crude international benchmark is substantially lower, trading now around $85. At its peak in June, a barrel had cost $115.

The dramatic decline in oil prices benefits India, but is obviously not so good for the oil producers. In normal situations, cheaper oil should boost global economic growth. This is because consumers in oil importing countries are more likely to spend the money quickly than cash-rich exporters. By boosting spending, cheaper oil can raise global output.

Do lower oil prices reflect weak demand or are caused by an abundant supply of crude? In the former case, weak demand may indicate economic slowdown. On the other hand, if the fall in oil prices is due to abundant supplies that may be potentially better news. Cheaper oil should boost spending and drive up the global economy.

The fact that there is no clear cut answer as to whether oil prices have fallen because of a slowdown in the world economy or because of abundant supplies is an indication of global uncertainty. This is something policymakers in India will have to reckon with. The global economy is certainly weak.

IMF’s outlook update

Just a fortnight ago, the International Monetary Fund in its World Economic Outlook update had forecast a slower than expected economic growth in the next year. India is one of the few countries that fared better in IMF’s assessment. Its growth rate, projected at well above 5 per cent for the current year, can go above 6 per cent next year, subject to India undertaking some much-needed reforms. But the IMF’s study has also pointed out that India’s potential to grow substantially higher is limited.

The U.S. economy, now firmly on the move up, and the U.K. are the only bright spots among developed economies. The European Union continues to be crisis-ridden. Japan’s GDP growth fell in the second quarter. But the biggest disappointment comes from two countries, which had hitherto spearheaded global economic growth — Germany and China.

Germany, the economic powerhouse of Europe and indeed of much of the world, has cut its growth forecasts for this year and the next by more than 0.5 percentage point. Germany’s potential to stimulate global growth is enormous. It runs a huge current account surplus. Yet, the German government is loathing for embarking on any type of stimuli.

On the face of it, China’s economy chugs along with above-average growth rates. However, there are doubts about its financial sector and its inflated property market. However, the correlation between slower global growth and falling energy prices is not as watertight as it appears to be. There has also been a big increase in the supply of oil.

Where the oil prices will stabilise even over the short-term is still a matter of conjecture. In these circumstances, India — which imports 80 per cent of its oil requirements — needs a clear and proactive strategy to ride over the uncertain global outlook.

(This article first appeared in The Hindu dated October 27, 2014)

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