Introduction
Oil prices determine the strength of the world economy and are an important determinant of the global economic performance. In the early years, the upward and the downward movements in the oil prices could be predicted more easily. But now due the increased speculation in the commodities market and also due to many other manipulation practices, the oil price could not be predicted easily. The forces of demand and supply are also out of the control. The major reason for the rise in the oil prices is because of the drastic increase in the demand for oil by the growth driven economies like China, India and US. The global financial crisis which has resulted from the sub-mortgage problem has resulted in huge financial loss for the international banks and other financial institutions. This has reduced their funding to new oil projects, which reduced the production level of oil. The rapidly growing oil demand without any increase in the supply is the primary factor for higher oil prices. Saudi Arabia, which is the largest producer and supplier of the oil, is approaching its limits. There are many factors that lead to uncertainty in the oil prices. The most important factor is the invasion of Iraq by the US and its associates. The Iraqi people were against this invasion and reacted against it. This resulted in increased violence, resulted in reduced exports and increased uncertainty. The political suspicions in Nigeria, War of Russia, and hurricane of US, all began to have an impact on rising oil prices. In addition to all these factors, the speculative investments in the oil sector by the financial investors also inflated the oil prices. The increased investments in the oil sector along with the increased demand for the oil made the oil prices to shoot up.
The demand for the oil price rise is indeed confusing, since the price of the oil was so drastic and has reached the peak. The rise in the oil prices has prompted for narrowing the government spending so as to make even the inflationary pressures. The increase in the oil prices sometimes could not make any impact on the balance of payment since there is better admittance to foreign exchange of big spenders. Many countries have able to face the pressure of oil price hike with out difficulty. For example China, which importing oil even under rising prices because it has got high earnings from its export. In the case of India, it has got high capital receipts from the supply of IT enabled services. Many other countries are able to manage the price hikes due to high transfer of funds from the migrant workers. But the US is dragging behind since it has got huge trade deficits because of heavy capital outflows and makes them a largest debtor country.
The global oil scenario has got many implications. Mostly the poorer countries suffer from the bad effects of oil price hike. The poorer countries could not easily access larger capital inflows; this will in turn affect their economy as a whole. The developing countries of Asia who are mostly depending on the Middle east countries for oil are the worst effected countries of oil shock. These poor nations are receiving lower quantity of remittances from abroad. Thus they have to regulate the rising oil prices by pressing their demands through contactionary policies, which will decrease the domestic incomes and will increase unemployment. Only through this method they can make good their balance of payment problems.
The countries also found it hard to retain the fuel subsidies and so many of the countries tried to neglect the subsidies. Because of all these factors, there remain uncertainties relating to the occurrence of global downturn.
The global recession will result because the trade deficit of US is expanding, and if the prices are ascending more, then the global growth will freeze. It is perceived that the there will be a swap between the growth and inflation, which will stress the government for adopting a contactionary monetary and physical policies so as to bring down inflation and also to accelerate the economic growth.
Increase in the oil prices will often result in global economic turn-down. The rise in the oil prices will shift the terms of trade from the importing to the exporting countries, thereby shifting the income also. There are both direct and indirect impacts on the increasing oil prices. The direct impact of the ascend of the oil prices depends on the share of the oil cost in the national income, the level of dependence of the country on the imported oil and the capacity of the end users to reduce the consumption of oil and find a substitution for it. It also has a direct impact level of gas production, which in turn has an impact on the electricity production, since it is generated from gas and oil. An increase in the relative prices of the energy input may put a pressure on the profit margins, which in turn increase the cost of production of goods and services in the economy. Therefore the higher the oil prices, it will have greater impact on the economy. But the oil exporting country like Saudi Arabia, Canada, Iran, Iraq, Kuwait, United Arab Emirates, Venezuela, Russia, Libya and Nigeria benefit from the oil price hikes because their real national income will increase due to increase in the export earnings. But in a later stage their earnings would decline due to the losses suffered from the economic downturn of their trade associates. Higher oil prices will result in inflation, increased input costs, drop in the non-oil demand and also reduction in the net oil importing countries. The magnitude of the inflation will depend on the degree of stiffen monetary policy adopted by the government and also the extent to which the consumers are willing to equalize their reduced real income through wage increases and the profit restoration by the producers.
The tax revenues will tend to crumple and the budget discrepancy will rise due to the inflexibility of the government expenditure, this will again turn up the interest rates. The nominal wage level also tends to increase due to the price hike because of the opposition of the real decline in the wages. The wage pressure together with the reduced demand will result in higher unemployment for a short span of time. If all these effects continue for a longer period of time, then it will have a negative impact on the consumer prices and also will affect the business confidence. The change in the oil price also has both direct and indirect impact on the financial markets. The increase in the oil prices will bring changes in the economic activity, commercial earnings, inflation and the financial policy, which will affect equity and bond values. It will also affect the balance of trade between the countries and also the exchange rates. The oil importing countries like USA, Japan, China, Germany, South Korea, France, Italy, Spain, India, Taiwan etc may experience a worsening in their balance of payments, putting down the exchange rates. Because of this the imports will become more costly and the exports less valuable leading to a reduction in the national income.
Impact of rising oil prices in the economy
The oil price hike has got first round effect and a second round effect on the economy. The immediate effect of the oil price hike is that the price of the gasoline and the heating oil will also increase being the elasticity of demand being too low in most stages of the production. This will again shoot up the consumer prices. The indirect effect is that when the consumer prices increase, the workers or the laborers try to bargain for higher wages so as to compensate for their actual income loss. This will result in inflation. If the workers or the laborers are successful in bargaining for higher wages, then the second round effect will become more serious. The firms will try to pass the pressure of the higher labor costs back to the consumers which in turn will rise the consumer prices. This will worsen the condition of inflation in the economy. Higher rate of inflation mean that the real income of the consumers are not increasing according to the increase in the consumer prices. This cycle will continue and will result in a permanently higher price rises than the initial rounds.
Another consequence of the rise in oil prices is that there will be a shift in the trade from the importing countries to the exporting countries, thereby benefiting the exporting countries. This will result in a shift in the real income from the consuming to the producing countries. The real income of the importing countries will reduce more than the exporting country. When the price of oil increases, the amount spend on the petroleum products will be more and the income spend on other consumer products will reduce, which effect in worsening the domestic demand if not it goes well with reduced domestic savings and high export demand. This will result in bulging of the current account surpluses in the oil exporting countries. In the consuming countries the reduction in the output and employment will vary between different sectors of the economy. The producers of the consumer durable products are worst hit due to the oil price hikes because they cannot pass the increased production costs on to the shoulders of the consumers since they are already suffering from reduction in their real incomes. Because of this all the negative effects will remain in the economy. The central banks of the country have to take adequate measures to reduce the general price levels. The central bank usually adopts restrictive monetary policy so as to prevent the economy from the effects of inflation.
In the developing economies like China and India, an increase in the oil prices will affect all the consumers and the major industries, especially on the big fuel users like airlines, trucks and plastic makers. How the rise in the oil prices affects the different countries is just analyzed. China is one of the major oil importing countries and is going to increase their oil demand in the coming years. In China, labor force is abundant and they are in the process of shifting millions of workers from the state owned public sector enterprises to more active privately owned enterprises. However, in China the wages are so low that the industries can rise the profit even though there is a continuous oil price hikes. Also the rise in the oil prices has encouraged the energy conservation of the country, which will effect the domestic energy consumption of China and in turn affect the industry and the product structures of the industry. The energy composition of China is different from that of the U.S since china is more dependent on the other sources of energy like coal, which accounts for more than 65 percent of the China’s energy expenditure. The country has also introduced a bill on renewable energy, and also in the process of developing nuclear power. In China, oil prices are affected by multiple factors like situation that exists in Iraq, the oil exports of Russia and the relation of US with Europe. The growth of the developing countries like China and India will slow down due to the effects of higher oil prices. Also, the domestic oil prices of China are heavily linked to the international market. They are using the oil as a source of fuel and the derivatives of oil are being used as a chemical base in so many manufacturing concerns. Thus higher prices of oil will affect all those manufacturing concerns and its products. It will result in inflation and will also alter the economic model, which focuses more on investments in the small industries rather than depending on heavy industries that are heavily dependent on the oil derived products. In India, Inflation is the major matter of concern due to the rising oil prices. This surge will in turn impose huge taxes on the people and increase the burden on the shoulders of people. Due to inflationary pressures, the interest income began to decline, which in turn resulted in the steady decline in the interest rates. This will rise the prices of the essential commodities.
The oil price surge also affects the European economy. The major effect is on the rise of the consumer prices and reduced competitiveness. The European companies are more dependent on the petroleum products and because of the oil price hike, their efficiency is decreasing. It has affected the cost of transportation and several other sectors that are dependent on the oil products. The government also takes adequate financial speculative measures so as to control the inflationary situations. Many other measures like an increased revaluation of the Chinese currency and currencies of other Asian countries.
Latin American countries are the major importer of capital and are heavily dependent on dollars. Latin American countries are the major producers and exporters of the oil, so they will be benefited from the rising oil prices. More investments will flow to these countries. So the rise in the oil prices may not probably affect the Latin American countries. Also they are more concerned about developing alternative energy resources and protecting their existing energy sources. But the price of the oil is a factor that affects the demand for alternative sources of energy that are the resultant of the petroleum products. If the oil prices are increasing continuously, these alternatives will become insignificant.
Sometimes, the oil price hike may not necessarily lead to inflation. The major reason may be of the reduction in the dependence of the developed and industrial economies on the oil imports. Another reason may be that the burden of the higher oil prices is borne by the workers that are spread across the globe and also those producers in the developing countries who are producing commodities other than oil. The prices of these commodities rise in proportionate with the rise in the oil price and in majority cases it shows a sign of decline in the prices. This will make the inflation to remain controlled even if the price of the oil tends to be rising.
Thus it could be concluded that the rise in the oil prices will bring all the negative effects to the economy by increasing the inflation rate, reduced employment, increased burden of taxes etc. The market regulators are now making constant efforts to reveal all the anti manipulation laws that is prevailing in the market and has made agreement for cross-border sharing of information. This will help the regulators to predict the oil-futures market and also detect the signs of threats more easily.