Wednesday, February 23, 2011

What If Oil Hits $200


I remember asking then Finance Minister  and now Union Home Minister P Chidambaram what would happen to India's economy if oil went to $200 a barrel as was being widely predicted towards end 2008. Since it was already $147 a barrel, that figure didn't seem impossible.

Modern history  was of course kinder to us. Not only did oil prices plummet, it brought down everything with it, including the global financial system. Actually, it was the other way round but, as many would argue, though it really does not matter.

Tensions in the middle east have pushed oil prices to $106 a barrel and analysts, I read in some reports, are predicting a return to the $147 regime. Perhaps that what oil speculators are waiting for and in some ways prepared for. The modus operandi is the same, the circumstances are different. This time its Gaddafi we are worried about. Last time it was Wall Street.

Fruits Of Growth

The Government here says the  key priorities for 2011-12 are controlling inflation, protecting the common man from rising food prices and ensuring the poor get a fair share of the  “fruits of growth”. Accordingly we can expect policies to be framed, is what the Business Standard says today. The newspaper also argues for tough moves to bring social equity, including steps like introducing inheritance tax.

I agree. I would add the Corporate Social Responsibility (CSR) contribution to that list. I will also propose a model for doing so in coming days. One I think would best take care of all interests. However, moves  to introduce greater equity by taxing the super rich should be matched with moves like reducing customs duties sharply on those products will help manage inflation.

That may include oil. But  oil is the big bear sitting in the room. And no one  knows  how to start this conversation. The bear has the potential to upset or wreck the best of monetary and fiscal calculations. And there are not too many of those going around in any case, given how we've been struggling with inflation for the last year or so.

So What Happens Now ?

So the situation is ripe for two kinds of outcomes. The first is that things get progressively worse till some distant  point - in many countries this is the point citizens spill out on the  streets. The second is that the system will give way because of the already accumulated heat of overheating.

The last time this happened (guess what, just three years ago), the system gave way. Wall Street collapsed, the banking system followed. And then froze solid. And of course asset prices of all types began falling. Unfortunately this period (and I say that carefully)  did not last long enough in countres like India.

Will the system give way? Possible, but unlikely at the global level because many systems (think Europe) have already given way ! What about India ? Well, India is more precariously poised because it tends to usually be like the frog that gets boiled without actually getting fully boiled. No, not in oil, in case you thought I was stretching the pun here.

The FM's Response

Fact is that oil prices are one of the many problems we face. And the one we have least control over. Fighting inflation requires some stern wielding of the monetary stick. And the time to raise or tighten interest rates is right now. We  should stop running from that. We need some strong fiscal measures as well, including managing tariffs. But that is not so much a matter of will.

And of course, the $200 question that I posed to the  Finance Minister's. Well, he admitted that he did not have an answer. Except to say that that things would get worse if prices went up. It struck me  he instinctively knew the economic system was strained badly  and would give way. Perhaps the  reasons were not so apparent. I am betting the same thing today.

1 comments:

The 1 Cee R Club « Dateline Bombay on 3:17 pm said...

[...] prices are rising. I asked in an earlier post whether we were ready for a situation when oil would hit $200 a barrel as has been widely [...]

 

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