The OPEC surprise

The Organisation of the Petroleum Exporting Countries, or OPEC, agreed last week in principle to cut the output of crude oil, the first such agreement in eight years. Since June 2014, a combination of sluggish global demand and roaring production increases had sent crude oil prices downward, well below the $80-100 a barrel range at the height of the commodity super-cycle. Many OPEC countries struggled to meet government budget commitments. Saudi Arabia, for example, has the highest budget deficit of the world's 20 biggest economies - and it is Saudi Arabia's pump-at-will policy for the past two years that has perhaps been most responsible for the decrease in crude oil prices. So the pressure for a deal is unsurprising. The in-principle agreement is not ambitious; it suggests reducing OPEC's crude oil output to between 32.5 and 33 million barrels a day from the current 33.2 million. Real concerns remain about whether the deal will hold together. Individual output caps for OPEC members have not been agreed yet; they are to be finalised and operationalised at the end of November. Nevertheless, crude oil prices rose worldwide in response.

For India, a rise in the price of crude oil is not good news. A large part of the Indian economy's robustness since 2014 has been because of the benign supply-side push of low energy prices. It has helped stabilise India's external account and made government finances look better. If OPEC manages to implement the deal, then New Delhi's fiscal arithmetic will come under severe pressure. The government's commitment to send the fiscal deficit down to 3 per cent of the gross domestic product can become harder to achieve, especially since the next general election, and the associated incentives to implement populist policy, is drawing ever closer. The government must resist any temptation to protect Indian consumers from the increase in oil prices. The progress that has been made on deregulation of pricing at the pump should not be squandered. Nor should duties on petroleum products be cut to compensate for increased prices. The Reserve Bank of India, which now targets consumer price inflation exclusively, will no doubt be particularly cautious about further interest rate cuts in this more uncertain environment. Thus, the implications for an overall revival of investment and growth in India are not favourable.

Some sectors, such as airlines - which have been flattered by low fuel prices in the past couple of years - will be particularly hit. Of course, energy companies may do better. Also relevant is the recent decision to lower natural gas prices, set every six months by a formula linked to crude oil prices. They have just been lowered by 18 per cent; six months ago, they were reduced 20 per cent. This will provide some insulation to the economy. Even if crude oil prices rise sharply after November, natural gas prices will not be affected until the next iteration of price-setting, which will come into effect on April 1, 2017. Thus, downstream users like power stations and fertiliser plants will benefit for a while - and the government, too, which subsidises fertiliser, will have some time to adjust. But the finance ministry must realise that the possible end of the period of super-low crude oil prices means that there has to be more urgency about reform, to provide a compensatory impetus to growth and efficiency.

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