Oil Price Shock, Pass-through Policy and its Impact on India

NIPFP Working Paper 99
[PDF]


N R Bhanumurthy, Surajit Das and Sukanya Bose
March 2012

Abstract

This paper analyses the impact of transmission of international oil prices and domestic oil price pass-through policy on major macroeconomic variables in India with the help of a macroeconomic policy simulation model. Three major channels of transmission viz. import channel, price channel and fiscal channel are explored with the help of a comparative static macroeconomic general equilibrium framework. The policy option of deregulation of domestic oil prices in the scenario of occurrence of a one-time shock in international oil prices as well as no oil price shock situation analysed through its impact on growth, inflation, fiscal balances and external balances during the 12th Plan period of 2012-13 to 2016-17. The simulation results indicate that the deregulation policy as such would have adverse impact on the growth as well as on the inflation. But if this policy is complemented with the policy of switching of subsidy bill to capital expenditure might result in positive growth effects only in the medium term. Given, the current pass-through policy, one-time oil shock has more intense adverse impact on growth and inflation in the year of shock while it mitigates slowly over time. The model shows that with the oil shock and with current partial pass-through regime, a 10% rise in oil prices result in a 0.6 per cent fall in growth while in the full pass-through situation, it can reduce the growth by 0.9 per cent. Overall, the paper argues that the pass-through has differential impact on growth and inflation over the 12th Plan period. Hence, the policy of oil price deregulation must be carefully weighed and prioritized.