A study based on US, India and Pakistan economy
The price of oil and inflation are often seen as being connected in a cause and effect relationship. As oil prices move up or down, inflation follows in the same direction. The reason why this happens is that oil is a major input in the economy. It is used in critical activities such as fueling transportation and heating homes. If input costs rise, so should the cost of end products.
The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis. This helped cause the consumer price index (CPI), a key measure of inflation, to more than double from 41.20 in early 1972 to 86.30 by the end of 1980.
However, this relationship between oil and inflation started to deteriorate after the 1980s. During the 1990’s Gulf War oil crisis, crude prices doubled in six months from around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in January 1991 to 137.9 in December 1991.
This relationship was even more apparent during the oil price run-up from 1999 to 2005, in which the annual average nominal price of oil rose from $16.56 to $50.04.
During this same period, the CPI rose from 164.30 in January 1999 to 196.80 in December 2005. Judging by this data, it appears that the strong correlation between oil prices and inflation that was seen in the 1970s has weakened significantly.
UNITED STATES OF AMERICA
Recent oil price rises having an impact on inflation. Oil price rises toward $56 a barrel supported by another shutdown at Libya’s largest oilfield over the weekend and geopolitical tensions following last US missile strike on Syria.
Libya’s Sharara oilfield was shut after a group blocked a pipeline linking it to an oil terminal, a Libyan oil source said. The field had only just returned to production, after a week-long stoppage ending in early April.
The outage adds fuel to a rally that started late last week after the United States fired missiles at a Syrian government air base. Brent crude LCOc1, the global benchmark, rose 74 cents to settle at $55.98, not far from the one-month high of $56.08. US crude CLc1 was up 84 cents to settle at $53.08.
Oil prices have also been supported by a deal led by the Organization of the Petroleum Exporting Countries to cut output by 1.8 million barrels per day for the first six months of 2017, to get rid of excess supply. Libya and fellow OPEC member Nigeria are exempt from cuts.
In a sign of OPEC confidence that the deal is working, Kuwait’s oil minister said he expected producers’ adherence in March to their supply cut pledges to “be higher than the previous couple of months.” However, that price rally has also encouraged production in other countries such as the United States, filling some of the gap left by OPEC-led cuts.
US crude inventories touched record highs both at the US storage hub of Cushing, Oklahoma, and in the US Gulf Coast in recent weeks, according to US government data.
Traders say the stubbornly high stockpiles and production growth have limited the upside to any rally, though stock draws may finally appear in coming weeks as summer driving season kicks in.
“US shale is going to continue to weigh on market. With refineries coming out of maintenance season, maybe we’ll see some real strength around here soon,” said Tariq Zahir, an analyst at Tyche Capital Advisors.
According to a Financial Times report some of the analysts at the recently held FT Commodities Global Summit said they expected oil prices to hover between $60 and $70 in the foreseeable future. After a long pause since the Great Recession consumers are paying more each month for goods and services in what seems to be a sustained pickup in rising prices.
A bigger-than-expected, 0.6 percent jump in the Consumer Price Index last month pushed the annual inflation rate to a five-year high of 2.5 percent.
“Consumer prices have gained momentum in recent months,” said Chris Christopher, an economist at IHS Global Insight. “This is not the best thing in the world for lower-income households living paycheck to paycheck.”
Rising wages for many households have apparently offset some of the recent gains in consumer prices. Retail sales last month rose 0.4 percent last month, as shoppers snapped up bargains at post-holiday sales.
Those sales figures were also driven by a surge in gasoline prices. But other categories, including transportation and apparel, also posted solid price rises.
Consumer confidence has also picked up since November as the uncertainty lifted surrounding of outcome the presidential election.
Uncertainty may be offset by a wide range of policy changes promised by the Trump administration and GOP-controlled Congress, which has pledged major overhauls in taxes and trade.
A tax cut for low- and middle-income households could spur consumer spending, helping to support prices increases.
Trump’s tough talk on trade could bring new tariffs on imported goods that further increase prices for consumers.
Uncertainty over the prospects for major changes in tax reform, trade infrastructure spending and the Affordable Care Act are among other Trump campaign pledges. It has complicated matters for the Federal Reserve, which has recently begun nudging interest rates higher.
In the past, the Fed has typically sought to use higher rates to cool off inflation and offset future price increases. Fed Chair Janet Yellen told senators that uncertainty about Trump’s policies has made the central bankers’ job more complicated.
As oil prices have begun rising again, those higher energy costs have begun working their way through the economy.
The producer price index, which measures the costs of producing consumer goods, jumped by 0.6 percent in January, a sign that consumer price increases are likely to continue.
Rising oil prices to be deeply felt on remittances and inflation. Pakistan an oil-importing country that can barely contain its current account deficit despite record-low energy prices, a rise in oil prices can possibly be an indicator of tough times to come.
Two of the major areas where the impact of rising oil prices will deeply be felt are remittances and inflation measured by the Consumer Price Index (CPI). Going by conventional wisdom, a surge in global oil prices will increase the rate of inflation in Pakistan.
Growth in remittances has slowed down in the current fiscal year. A trend that many analysts attribute to reduced global oil prices causing a cut in public spending in the oil-rich Arab countries. After all, the share of remittances from the oil-rich Gulf nations in Pakistan’s remittances is almost 65 percent.
According to a recent research conducted by the State Bank of Pakistan (SBP) economists, these assumptions may not be 100 percent correct.
Noting that the slowdown in remittances growth was expected in view of the fiscal constraints in the Gulf region, the SBP economists said it was “still higher compared with other countries.”
Despite record-low oil prices, the number of Pakistani workers going to the Gulf countries has risen in recent months, the SBP said in its latest report on the state of Pakistan’s economy.
As many as 946,571 Pakistanis went abroad in Jul-Dec 2015, which translates into a growth rate of 25.8 percent over the same period of 2014, statistics released by the Bureau of Emigration and Overseas Employment show.
SBP researchers undertook an exercise in which they kept oil prices constant at the level of October 2014 and then re-calculated headline inflation for the next 14 months.
Inflation would still show a declining trend even though the direct impact of the fall in oil prices was excluded, according to the result.
Forecasts about oil prices have been wrong in the past. Inflation will inch up definitely because of the 4 percent direct impact of oil prices on the CPI.
The recent OPEC and non-members’ agreement for an oil production cut by close to two million bpd (barrels per day) is projected to have a visible effect on the economy of Pakistan, which imports 80 percent of its total oil consumed.
An increase in oil prices would trigger a trickledown effect on the economy impacting, ultimately, GDP, balance of payments, fiscal deficit and ending into inflation, by and large.
According to the available statistics from Pakistan’s ministry of finance, last year the government had successfully brought down the fiscal deficit from 5.3 percent to 4.3 percent, aiming for a further decline to 3.5 percent till 2018.
Despite the decrease in budget deficit, the recent increase in oil prices indicates that the government is short on revenue, resulting in an increase in oil prices aimed to meet expenses.
This proves that Pakistan’s economy is affected by the international increase in oil prices and fiscal deficit will continue to increase.
Fuel taxes are the principle source of indirect revenues in Pakistan and the consumption of petroleum products are comparatively price inelastic and income elastic.
The government fluctuates the prices through Petroleum Levy Development in order to generate the revenue according to its needs.
An increase in the import bill would also have a significant impact on the balance of payments, in turn contributing to inflation.
In 2008, the account deficit was increased by 17 percent (US$ 4.784 billion) and the government was able to offset the burden through the external financial sector.
In Pakistan, energy and transport sectors are the major consumers of oil (the share of transport, power, and industrial, agricultural in oil consumption remained 55, 35, 12 and one percent respectively).
The increased oil prices will not only have repercussions on the fiscal budget and balance of payments, but will, as a result, also increase the prices of electricity, transport, gas, edibles and machinery in market.
Considering this, government should come up with effective policies and plan to curb the current rise in international prices. The government should shift towards alternative sources for energy production.
RISING OIL PRICES PRESENT A CHALLENGE TO INDIA’S GROWTH
The Economic Survey’s concern over crude oil prices stems from India’s energy import bill of around $150 billion, expected to reach $300 billion by 2030. Rising oil prices present a challenge to India’s growth, a recent Economic Survey presented in parliament said. “Price of crude oil (Indian basket) has increased from $39.9 in April 2016 to $52.7 in December 2016,” the Survey said.
The concern over crude oil prices stems from India’s energy import bill of around $150 billion, expected to reach $300 billion by 2030.
India imports around 80 percent of its crude oil and 18 percent of its natural gas requirements. India imported 202 million tonnes of oil in 2015-16.
“Some possible challenges to growth exist. For example, the prices of crude oil have started rising and are projected to increase further in the next year. Estimates suggest that oil prices could rise by as much as one-sixth over the 2016-17 level, which could have some dampening impact on the growth,” the Survey said.
“Summarizing rising oil prices are very much a possibility. For an economy which is vulnerable to any fluctuation in oil prices, it is better to err on the side of caution,” said Deepak Mahurkar, leader (oil and gas) at PwC India, a consultancy.