How Oil prices affect an Economy ??

We many a time came across to the news about Oil price (known as Crude Oil) fluctuations, upwards or downwards in the international market and quite often we ignore such news believing as it won’t affect our lives, especially the households. However, in reality, oil prices considered one of the major factor of an economy, affect all kind of sectors whether it is household sector, business sector or Government. Now dive straight into it and figure it out how does it affect an economy.

If you consider the current scenario of the world market, where oil prices are surging sharply to the levels around $80 per barrel, initially affect transportation the most. Rising oil prices negatively affect an economy, especially economy like India where around 80% of India’s oil consumption is being imported. A Rise in oil price Increases transportation cost such as a rise in airplane fuel cost, which leads to costlier airline tickets. Similarly, many other industries like chemical, paint, oil refining, tire etc. using oil as their input directly correlated with oil prices and are forced to raise the price of their goods as oil price increases. In addition, companies are then bound to pass on the increased prices to the ultimate consumer resulting in higher prices of goods and services. Higher rates of goods and services give a push to another severe issue called inflation. Yes, increasing oil prices severely affect inflation, as you see above how companies are compelled to set off their increased input cost (oil) with the increased price of final goods & service leads to higher inflation in the economy.

Higher oil prices also upset stock market, not completely but majorly. The oil happens to be the input for many companies such as refining, footwear, lubricants, logistics, chemicals, paints etc. and increase in the price of oil also increase their input cost which sooner or later reduces their profit margins, so as to their share prices

A rise in Oil prices disturbs Banking sector too, as oil prices directly correlated to inflation. A higher oil prices increase inflation in an economy and a rising inflation is a big concern to any central bank and to tackle the same central bank may hike Policy rate (Like Repo rate in India) which increases the cost of borrowing, results in slower growth. Although rising oil prices negatively affect an economy It also has some positive outcomes for some industries like Oil substitute industries, Electric car industries etc. because of the substitution effect.

As you can see rising oil prices severely affect an economy, declining oil prices also have some negative effect. When oil prices plunge, oil-producing countries have to cut its oil production, resulting in a halt in the energy sector, which ultimately scale down the job growth. Reducing oil prices also affect the banks, as banks generally have some exposure towards oil and gas companies in terms of loans given to them. Because of steep fall in oil prices reduces the profit margin of oil and gas companies and therefore, banks have to increase their reserves for potential losses towards loans made to those oil and gas companies, hits banks profit margin too.

Extremely low and high oil prices both are not good for an economy. It should be maintained at an optimum level that provides the maximum level of advantages to various economies and sectors.