January 31, 2011Economyenergy securitygeoeconomicsmacro economicsPublic Policy

Relating the fiscal deficit to the price of oil

Every $10 increase in oil prices causes a fiscal deficit of between 0.6% to 1.3% of GDP

This is an archived blog post from The Acorn.

One of the issues discussed at last weekend’s Friends of Takshashila meeting in Singapore was the relationship between fiscal deficit and the oil price. Aditya Palwankar, who was there, has this to share:

I had mentioned that every $10/bbl rise in oil prices would impact India’s fiscal deficit by 0.8% of GDP. In fact, as a recent report by Morgan Stanley suggests, it is even worse. It suggests 0.9% of GDP in FY2011 ($85/bbl) and 1.3% of GDP for FY2012 (assuming oil prices at $100/bbl) as the additional subsidy on account of oil price rise.”

Our Oil and Gas analyst Vinay Jaising estimates the under-recoveries at US$14.3bn (0.9% of GDP) for F2011 (12-months ending March 2011), assuming oil at US$85/bbl for F3Q11 and US$90/bbl for F4Q11. For F2012, assuming oil averages US$100/bbl, he estimates oil subsidy burden of US$24.7bn (1.3% of GDP). In fact, for every incremental US$1bbl change in the crude oil price, he estimates the subsidy burden to increase by ~US$612mn in F2011 and US$629mn for F2012. [Chetan Ahya/Morgan Stanley]

Mr Palwankar adds: The relationship is deduced as follows: sum total of all subsidy on account of oil (LPG, Kerosene, HSD, Petrol and ATF) divided by the nominal GDP of the country. For FY2011 (Apr-Mar), Morgan Stanley expects total subsidy to be $14.3bn and India’s nominal GDP is expected to be $1,600bn. Hence dividing the two we get 0.9% of GDP.

Of course, the 0.8% to 1.3% range is assuming oil prices between $85-$100/bbl and real GDP growth of 8% and nominal GDP growth of 14-15%.

But these appear to be best case scenarios because if oil prices go up to say $120/bbl, there will be a triple whammy, namely a spike in current account deficit (funded through capital flows), increase in oil subsidy (funded through the fisc) and slowdown in economic growth (due to lack of capital). I am not counting the impact on inflation here, to sound not too negative. On the other hand if oil prices come down to $80-85/bbl, we will still be in the region of 0.6-0.7% of GDP in F2012 assuming a nominal GDP growth of 15% and no change in oil prices.

(Let us see) India’s oil subsidy in the context of what it costs to build efficient public transportation systems in urban India. Delhi Metro phases 1 & 2 costs were estimated at $3.3bn in 2004. Even if you were to adjust the cost for inflation (at 10%), it would not cross $6bn. Oil subsidy in each of the previous five years has been at least upwards of $5bn. Had we spent this subsidy in building long term efficient public transportation systems instead, we could have made some impact on the rising demand for oil as also reduce the severe congestion we find on Indian roads.”

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