Rising oil prices

Rising oil prices

While the political implications of the battlefield victories of Islamic insurgents in Iraq are slowly becoming clear, their economic impact has already been felt.

 Sunni jihadists led by an al-Quida affiliate, the Islamic State of Iraq and Syria, have taken the country’s second largest city, Mosul, and is advancing towards Baghdad. Another insurgent group of Kurds have taken control of the northern oil-producing centre Kirkuk. Iraq is the second largest oil producer and exporter in the Organisation of Petroleum Exporting Countries (OPEC). The threat to the Iraqi government, the prospect of destabilisation in the region and the resulting uncertainty have pushed up oil prices in the world market. They are now at a nine-month high on fears of disruption of supplies in the coming weeks. Brent crude futures have risen by over 3 per cent to $ 114 per barrel in the last few days.

A rise in oil prices will seriously hit the incipient growth of the world economy. It will also adversely affect the prospects of a turnaround in India. There are fears that continued rise in oil prices will fuel inflation in all economies, both in developed countries and others. The central banks everywhere may have to increase interest rates to keep inflation under check. Even in the US where inflation is not a major threat now will have to plan for such an eventuality.

This will hit economic recovery at the global level. The stock markets have already reacted with a correction all over. Gold prices, which were on a downtrend, have flared up on increased buying on fears of rising inflation. Most of Iraq’s oil-producing facilities are in the Shia-dominated southern areas where the government still has control. But the collapse of the Iraqi military in the north has cast doubts over the assurances of the government about the safety of the oil fields. Even if there is external intervention, the uncertainty and the unsettled conditions are likely to take the oil prices still higher.

India will be especially vulnerable because of its high dependence on imported oil. It recently replaced Japan as the world’s third largest oil importer. West Asian countries account for most of the imports, with Iraq contributing about 14 per cent of the supplies. Higher oil prices will swell the import bill, worsen the current account deficit, which was improving, and increase inflationary pressures. It will present hard policy choices to the government and the RBI.