Why in the News?

• Rising geopolitical instability in West Asia is impacting India’s economy through oil prices, currency depreciation, and fiscal stress.

What’s in Today’s Article?

• Global Tensions (Background, Channels of Transmission, Oil Price Volatility, Investment Trends, Way Forward, etc.)

Global Tensions and India’s Economy

• Geopolitical tensions, especially in energy-rich regions like West Asia, significantly influence India’s macroeconomic stability.
• India imports over 85% of its crude oil, making it highly vulnerable to external shocks.
• Recent developments show how global conflicts can directly affect domestic indicators such as inflation, fiscal deficit, and exchange rates.

Channels of Transmission

• Energy Prices
  • Oil prices act as the primary transmission channel of global shocks.
  • The Indian crude basket touched $156.29 per barrel recently.
  • A $10 rise in crude prices can increase inflation and widen the current account deficit.
  • Higher oil prices increase transport costs, production expenses, and overall inflation in the economy.

• Exchange Rate Pressure

• The rupee depreciated to a record Rs 95 per dollar.
• The Reserve Bank of India has used foreign exchange reserves to control volatility.
• Currency depreciation increases import costs and worsens inflationary pressures.

• External Sector Stress

• Foreign exchange reserves declined to around $709 billion.
• Foreign portfolio outflows have intensified due to global uncertainty.
• This weakens India’s external stability and increases vulnerability to global shocks.

Fiscal Impact of Oil Price Volatility

• India’s fiscal system is structurally exposed to oil price fluctuations.

• The country imports around 85-87% of its crude oil.
• Oil price increases lead to higher subsidies on fertilisers and LPG.
• Governments often reduce fuel taxes to control inflation.

• For example, earlier excise duty cuts led to significant revenue losses, while subsidies expanded sharply.
• If oil prices remain high, government expenditure may rise substantially, while revenues may decline due to reduced consumption.

Changing Revenue Structure

• India’s revenue system is increasingly dependent on transaction-based taxes.

• GST collections have risen significantly, reaching Rs. 22.8 lakh crore.
• Revenue growth is driven more by economic activity than income growth.

• This makes fiscal stability vulnerable to shocks that reduce consumption and transactions.
• During crises, lower consumption reduces GST collections, affecting government finances.

Impact on Households

• Households are a key channel through which economic shocks are transmitted.

• Private consumption accounts for about 61.4% of GDP.
• Household liabilities have increased to over 41% of GDP.

• Rising debt levels make households more sensitive to inflation and income shocks.
• Higher energy prices increase household expenses, reduce disposable income, and weaken consumption demand.
• Additionally, disruptions in LPG supply chains have led to higher costs and shortages.

Industrial and Investment Trends

• India’s industrial growth shows a mixed pattern.

• Manufacturing growth remains strong, especially in capital-intensive sectors.
• Labour-intensive sectors remain weak.

• Private investment continues to lag despite increased government capital expenditure.
• Only a small proportion of announced projects are completed, indicating cautious investment behaviour.
• Small businesses and informal sectors are more vulnerable to shocks, as seen in reduced demand and closures during recent disruptions.

Macroeconomic Contradiction

• India’s economy currently reflects a dual reality.

• Strong GDP growth (around 8.1%) and high capital expenditure.
• Weak income growth, rising debt, and external vulnerabilities.

• This divergence highlights structural weaknesses in the growth model.
• While infrastructure-led growth boosts long-term capacity, it may not immediately strengthen household incomes or consumption.

Way Forward

• India needs to recalibrate its economic strategy to reduce vulnerability to global shocks.

• Diversify energy sources to reduce dependence on crude oil imports.
• Strengthen income-led demand through employment and wage growth.
• Broaden the tax base to reduce reliance on transaction-based revenues.
• Maintain adequate fiscal buffers for crisis management.

• A balanced approach between growth, stability, and resilience is essential in an uncertain global environment.