South-Western College Publishing - Economics  
Energy Prices Affect World Economy
Subject Energy Prices
Topic International Trade
Key Words

Economic Growth, Inflation, and Energy Prices

News Story

Global oil prices have risen to more than $44 a barrel and analysts around the world are forecasting slower growth and possible inflation.

Take India for example. In 2003, India paid an average of $26.70 per barrel of oil compared to the current $44. Analysts estimate that for each $5 per barrel increase in the average price of crude, India's economic growth could fall by 0.25 percentage points.

"Oil prices have gone through the roof, and that is adversely impacting the economy and industry," said D.D. Rathi, chief financial officer of Grasim Industries, a large cement producer. "It is starting to pinch," he said.

In the fiscal year that just ended, India's economy grew at 8.2 percent and was the second-fastest growing country in the world after China. Increasingly costly oil is expected to lead to higher inflation, lower private consumption, and slower economic growth.

"If global crude oil prices move up by $5 a barrel for the full year, then India's inflation rates rise by 0.5 percent to 0.6 percent and G.D.P. rates fall by 0.25 percent," said Chetan Ahya, India economist and senior vice president at JM Morgan Stanley.

Mahesh Vyas, chief executive of the Center for Monitoring of the Indian Economy, agrees with lower growth predictions, but said that India's inflation might not be so bad if firms do not pass on the higher energy prices to consumers. He doesn't expect the inflation to be as bad as some say, because he thinks "many of their costs, such as interest costs, are declining." He adds however, "With rising oil prices and a worrying monsoon, we will possibly reduce our gross domestic product forecast from 6.3 percent to 6 percent."

Higher energy prices translate into slower growth as increased costs trim company profit margins. Additionally, as firms pass higher energy prices on to consumers, inflation occurs. Multiply this scenario by the many countries that depend on foreign oil and it is easy to see how higher energy prices will affect the world economy.

(Updated October, 2004)

Questions
1.

Why do you think higher energy prices slow economic growth?

2. What effect will inflation have on India's consumption spending?
3. How do higher energy prices affect the rate of inflation?
Source Saritha Rai, "India's Economic Growth Is Expected to Slow", New York Times Online, August 6, 2004.

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