Oil Supply Shocks and India’s Current Account

A negative crude-oil supply shock is an unexpected reduction or threatened reduction in global oil availability that raises prices and may disrupt supplies. Because India is a net oil importer, such a shock usually weakens its current account balance, which records trade in goods and services, primary income and secondary income with the rest of the world.

Transmission to the current account

Imported crude is recorded as a merchandise-import debit. If its global price rises while import volumes change little, India pays more foreign exchange for oil, widening the trade deficit and, other things unchanged, the current account deficit.

• The shock worsens India’s terms of trade because more exports are required to purchase a given quantity of imported oil.
• Oil demand adjusts slowly in the short run, so the import bill may rise substantially before consumption and production patterns change.
• Severe supply disruption can also constrain domestic production and exports, creating an additional adverse channel.

Factors determining the magnitude

The effect is not mechanical because the current account includes several transactions beyond crude imports.

• The impact depends on the size and duration of the price rise, oil-import volumes and the economy’s energy intensity.
• Higher earnings from refined-petroleum exports can provide a partial offset, although these exports also require imported crude.
• A services surplus and inward remittances can cushion the overall current account even when the merchandise deficit widens.
• Depreciation and slower growth may eventually compress oil and non-oil imports, partly correcting the initial deterioration.

Macroeconomic adjustment

A larger deficit increases India’s external financing requirement. It must be matched through net financial inflows or an adjustment in foreign-exchange reserves, exchange rates and domestic demand.

• Higher oil costs can raise inflation and production costs, while currency depreciation further increases the rupee cost of imported energy.
• Diversified energy sources, improved efficiency and temporary use of strategic petroleum reserves can reduce short-run vulnerability, though reserve stocks must later be replenished.