If Israel threatens to bomb Iran or if an ethnic unrest in Nigeria makes country’s ruling government shaky, does it matter to the life of a clerk in Karnataka government? Though these two are isolated political developments in two small countries, they do have an important bearing in the life of a common Indian through international oil prices.

The price of crude oil in the international market has more than doubled in the last one year, it has just touched $142 a barrel and is likely to reach $200 by the end of this year.

Since Iran and Nigeria are two major oil producing countries, any possibility of disruption in production pushes up global oil prices. Since the global supply of 86 million barrels a day is just about enough to meet the global demand for oil, slight imbalance causes major price fluctuations.  

Crude shock

The spike in oil prices has led to a double whammy for the vast majority of Indians who depend on fixed monthly income for livelihood. Rising inflation is pushing up monthly household expenses while small increments in income and a negative return from investment are making him poorer. 

Generally speaking, people in India today are a victim of an economic situation loosely described as ‘stagflation’ — where rising inflation is accompanied with stagnation or contraction of the economy.

Thanks to shooting oil prices and rising commodity prices, the rate of inflation has already touched 11.4 per cent — highest in the last three years. Economists are predicting that inflation will go up further in the next couple of months as another dose of oil price hike is not ruled out. 

Stunned growth

The economic growth, on the other hand, has decelerated significantly. In March 2008 the index of industrial production (IIP) rose only by 3.9 per cent and in April it went up by 7 per cent over the same month last year. The growth in industrial production in April 2007 was 11.3 per cent.

Today there are many industries where slowdown is imminent. Sales of cars, motorbikes and tractors in May 2008, for example, were lower than last year. Higher cost for road transportation resulted in lower demand and sales of commercial vehicles.

To woo reluctant buyers for consumer electronic products, computers and branded garments, stores are offering huge discounts.

Associated with this is the lack of new job creation and job losses. The huge Information Technology (IT) industry in the country, which largely depends on software development jobs for clients in the US and in Europe, have virtually stopped hiring and have started selective firing. The bad news is that subprime crisis that has engulfed the entire financial sector in USA and Europe, is getting worse with bigger write offs. The total loss in the USA is expected at around $700 billion. 

Little control

Spiraling inflation is making people poorer but there is very little that the government can do. The rate of inflation rose above 11 per cent soon after the government raised the prices of petrol, diesel and cooking gas in the first week of June.

Close to ninety per cent of the incremental inflation was contributed by oil and its linked-usage.  Rising commodity prices too contributed to inflation. The main culprit, however, is rising international prices of oil and commodities, which again was the result of a global mismatch between demand and supply. It is always better to pass on the increased oil prices to consumers because price protection through subsidies does not force a cut in consumption and ultimately benefit oil producing countries.

A huge burden

Had the government not raised the oil prices, its subsidy bill to the domestic oil marketing companies would have shot up by another Rs 21,000 crore.

This, in turn, would have forced the government print more money leading to over all inflation. Either way, Indians will have to pay for higher oil prices as 70 per cent of our oil requirement is imported. Just how severe is the oil price blow for India? Consider the following: India’s monthly oil import in June 2008 is averaging at $7.7 billion (Rs 33,000 crore), 43 per cent higher than the monthly average of $5.4 billion (Rs 23,000 crore) in 2007.
At current prices India’s annual oil import bill will touch Rs 400,000 crore and the annual subsidy from the government to the oil marketing companies is likely to touch Rs 300,000 crore even after the price increase and duty cuts.

This huge burden along with subsidies on fertilizer and food grains is likely to cause a major imbalance in the government’s balance sheet in 2008-09. 

Poorer in real term

As inflation is making things expensive, people’s income is being squeezed in real terms. A person becomes poorer unless his income exceeds the rate of inflation, now at 11.40 per cent.  In the face of a slowdown the salary increases in most industries are expected to remain subdued. People can’t make money from investments either as returns are lower than inflation.

With the Reserve Bank of India (RBI) increasing the interest rates and CRR, banks have started raising the interest rates. While the prime lending rates are now being raised to 13.5 and 15.5 per cent, banks are not offering more than 9.5 per cent interest (slightly higher for senior citizens) to depositors.

This means that by keeping money in time deposits one will become poorer in real terms as inflation now is 200 basis points higher than that. Banks are not in a hurry to raise deposit rates because they are flush with funds from depositors.

Debacle in stocks

But there are very few options where one can invest. Those who had invested in company shares have lost heavily as the stock markets have crashed 8,000 points from 21,8000 in the first week of January 2008 BSE Sensex has now dropped to 13,800.

Out of 5,500 shares listed in BSE 1,500 are not trading at all and of the top 500 companies nearly 50 per cent are quoting below their 52 week low.

Even the mutual funds, considered relatively safe for risk-averse investors, have fared badly due to steep and sudden drop in share prices.

Investing in property is not risk free either. Property prices, which were artificially boosted by the builders and speculators, have softened considerably and more importantly, the resale market is suffering due to lack of interest from buyers.

In fact the realty industry is being squeezed from two ends — prices of steel and cement have shot up and home loans have become more expensive. Investing in gold is not risk free because gold prices too fluctuate wildly due to the play of international forces on demand and supply.

Exploiting poor

The worst economic impact of inflation is that it hurts the poor much more than the salaried people in the organised sector. Workers in small factories, labourers in construction activity and daily wage earners are the first to lose jobs when cost cutting sets in.

Even when they have job, it is virtually impossible for the workers in the unorganised sectors to extract a wage hike to compensate for the price rise. 
 
The white collar workers and workers in the organised sector are better placed as their income is partially protected by the variable dearness allowance that moves with inflation.

Being unionised this group also has better bargaining power for a wage hike. The good news for the country is that the monsoon rain is expected to be normal and we are likely to see a bumper food production. While this will soften price of food basket, we will still have to live with the vice of very high oil prices.

Though the Indian economy is resilient enough to bounce back from the crisis, the sentiment now is low in the absence of any good news.