Middle East Crisis and Rising Oil Prices

Posted in Finance Articles, Total Reads: 3602 , Published on March 12, 2011

It is a flat world where events do not occur in isolation. What happens in part of the world has its ripple effect in other part of the part. The free flow of capital goods and services across the borders has resulted in unprecedented growth of world economy particularly in Asian economies.  As the unrest spreads among Middle Eastern countries like Egypt, Libya, Algeria, Yemen and Bahrain, world economy which was seeing signs of improving sentiments, has again adopted a very cautious approach. The main reason of this grim situation is the rising oil prices which have already touched $115 per barrel. The region provides 35% of the world’s oil. Libya produces 1.7m of the world’s 88m barrels a day. Egypt which was first country when unrest began can have considerable effect on the trading activity in that region.


Middle East Crisis and Rising Oil Prices

It is the same country that owns and maintains the Suez Canal, a key port that still handles a large traffic of commercial ships, larger than the Panama Canal. A prospect of closing down of the port means an additional roundabout journey of approximately 6,000 miles, equivalent to 21 days, and consequently, additional fuel consumption. It can prove to be a chokepoint for a number of raw materials and finished goods.  Of the total 35,000 ships crossing the Canal in 2009, almost 10% were oil tankers. Yet, it is significant to note that the total tonnage of oil through the port accounts for only 2.3%-5% of total oil shipments across the globe. Nevertheless, opinions are divided on the possible impact on the already high crude oil prices.


The worst-case scenario for oil prices would be some kind of disruption to Saudi supply itself. Unrest in Bahrain has already raised these concerns. The tiny island kingdom produces little oil but is of vital strategic importance in the Persian Gulf, a seaway that carries 18% of the world’s oil. America’s 5th Fleet uses the country as a base.


What does it mean for country like India which imports two third of their oil needs.  An increase in the price of oil can cause a steeper jump in inflation, because it has a larger weighting in the consumers’ baskets, 14.2%. Moreover, energy is a large input in food production, which has an even bigger weight. Thus any rise in oil price will raise the inflation which is already very high. What can reserve bank of India do to protect the economy? Higher oil prices act as a tax on countries that import the stuff, which would normally call for easier monetary policy. But they also raise inflation, which calls for tightening.


RBI has hiked key policy rates seven times since March 2010 to tame inflation, which came down to 8.23 per cent in January from over 10 per cent in June last year. A World Bank report recently said the rising food prices have pushed 44 million into poverty. In India, however the food inflation has come down to 11.49 per cent in second week of February from over 18 per cent in December last year.


There have been few steps taken in the budget to reduce dependency on oil.  Sops have been announced for lowering fuel consumption, such as customs duty exemption on hybrid vehicle parts and batteries for electric vehicles, and announced direct transfer of subsidies to needy people using kerosene and cooking gas.  All these are long term measures to reduce oil consumption but in the short run RBI will have to play the guessing game of predicting where oil prices are headed.  Anti inflationary focus of monetary policy is likely to continue, recognizing though the limits of monetary policy in dealing with inflation and the need for forward looking response to demand side pressures. Since a lower inflation regime is essential for sustainable high growth, containing inflation becomes the dominant policy objective in the current environment.


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