Intro: India has to decide, whether to buy expensive oil from Saudi Arabia in dollars or cheap oil from Iran and Russia in rupees. Modi Government has done well in resisting the United States pressure and pushing ahead with rupee trade with these countries. It should stay on course.
I had previously written in Organiser that the price of oil is likely to remain high. The caveat I had placed then was development of a new source of energy such as that of producing electricity from thorium would lead to a fall in energy prices. Such a happy circumstance has indeed been unfolded at present with the increasing production of shale oil. Large amount of oil is stored in the rocky bowels of the earth. The cost of extracting this oil is about US Dollar (USD) 60 per barrel. It has become economically viable to extract this with oil prices remaining around USD 100 in the last decade. The availability of oil in the world market has increased due to the increased production from this source. This has led to a decline in price of oil.
The demand for oil is declining at the same time. Growth in China, Japan and Europe is stagnant. The increase in supply along with decrease in demand has led to the present crash in the global oil price from USD 100 to USD 60 per barrel. The price of diesel and petrol has been reduced in the country alongside.
Members of the Organisation of the Petroleum Exporting Countries (OPEC) produce about 40 per cent of global oil. Saudi Arabia is the leader of OPEC. Saudi Arabia does not want the US shale production to stabilise. The cost of extracting fossil oil is about USD 12 ber barrel for Saudi Arabia against USD 60 for shale oil. Previously OPEC used to reduce production whenever oil prices declined, leading to reduction in supply and stabilising of prices. But this time OPEC has refused to cut production. OPEC is willing to live with falling prices so that US shale oil production comes to a halt and the dominance of OPEC on world oil markets is retained.
Another reason for Saudi Arabia to continue pumping oil is that it is locked in a bitter war of nerves with Iran for dominance in the Arab world. The Saudi strategy is to destabilise the economy of Iran by lowering the price of oil. Unlike Saudi Arabia, Iran does not have huge foreign exchange reserves to withstand a decline in oil price for a long time. Saudi Arabia is no friend of Russia either, since the latter has supported Iran. Both these countries are heavily dependent on oil exports. Saudi Arabia wants to kill these economies through low price of oil. The Russian ruble, for example, has declined from 53 to 75 Russian rubles to a dollar in the last few days. Saudis are targeting US shale oil, Iran and Russia—all with the single bullet of cheap oil.
But these are short term tactics. Ultimately the Saudis would like the price of oil to remain high because that is how they make most of their money. Consequently, I expect the present decline to be temporary. The price will bounce back as soon as the Saudi strategy against shale and Iran plays itself out.
India is helping Iran and Russia in facing the Saudi pressure. Former Prime Minister Manmohan Singh had wilted against US pressure and reduced oil imports from Iran. Modi Government has reversed that policy and allowed imports of oil from Iran against rupee payment. A similar arrangement is on the anvil with Russia. The recent visit of Russian President Vladimir Putin saw an agreement being signed on increasing bilateral trade between Russia and India in rupees. An agreement was also made to speed up the laying of a pipeline from Russia to India for the shipment of oil. These moves are enabling Iran and Russia to face the US-Saudi pressures. No wonder, the US has criticised these moves. India has to decide whether it wants to buy expensive oil from Saudi Arabia in dollars or cheap oil from Iran and Russia in rupees. Modi Government has done well in resisting US pressures and pushing ahead with rupee trade with these countries. It should stay on course.
One fall-out of the present scenario has been the exit of foreign investors from Russia. Decline in oil prices has throttled the main source of foreign exchange earnings for that country. The earning of dollars by the Russians is declining while demand for imports of goods remains as previously. This has led to decline in the value of the rouble against the dollar. Foreign investors have taken a bit hit in the process. They are selling their holdings and seeking exit from Russia. This is leading to a global risk aversion. Foreign investors are inclined to exit from other developing countries as well. They have sold their holdings in India and remitted the monies to their home economies. This has led to a decline in the sensex from 28K to 26Kand the rupee from Rs 60 to Rs 63 a dollar.
We will have to choose whether we want the short term benefits from FIIs in India; or the long term benefits of cheap oil. I vote for the latter. The problems faced by us due to the decline in the rupee and exit of FIIs will be of a short duration. The rupee will stabilise once the FIIs have completed the exit. But benefits of cheap oil will continue for long.
India must adopt the following strategy in these circumstances. One, we should increase import tax on oil imports and put the earnings in a reserve fund. This will lead to increase in price of oil in the domestic economy and prevent our getting hooked to ever-increasing oil imports that threaten our economic sovereignty. The reserve fund may be utilised for implementing energy saving measures such as installation of roof top wind generators and solar panels, replacement of incandescent bulbs with LED lamps, introduction of hybrid cars, and time-of-the day electricity metering so as to reduce demand of electricity during peak hours. These measures will help reduce our dependence on imported oil in the long run and help protect our economic sovereignty.
Two, we must give lip service to the US by inviting President Obama as the chief guest during the Republic Day function but strongly persist with our strategy of promoting bilateral rupee trade with Iran, Russia and even China. This will break the Saudi strategy of increasing the price of oil once the economies of Iran and Russia break and shale oil production in the US comes under pressure. It is clearly in our favour to ensure long term cheap supplies of oil against rupee payment from these countries.
Three, Modi must revisit his strategy of “Make in India by MNCs” and instead promote “Make in India by Indians.” Such realignment will reduce the dangers of FIIs exiting and leading to collapse of the rupee.
Dr Bharat Jhunjhunwala (The writer is the former Professor of Economics at the Indian Institute of Management (IIM), Bengaluru)