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

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 of oil price shock viz. import channel, price channel, and fiscal channel are explored within a structural macroeconomic framework. The policy options of gradual 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 are analysed for their impact on growth, inflation, fiscal balances and external balances during the 12th Plan period of 2012–2013 to 2016–2017. The simulation results indicate that in the short run the deregulation policy 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 it might result in positive growth effects in the long run. Given, the current pass-through policy, a 10 % rise in oil prices result in a 0.6 % fall in growth while in the full pass-through situation, it can reduce the growth by 0.9 percentage point on an average. Overall, the paper demonstrates that the extent of pass-through has differential impact on growth and inflation over the 12th Plan period. Hence, the policy priority of oil price deregulation must be carefully weighed.