The Hindu Business Line : Brighter side of expensive oil

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Brighter side of expensive oil

S. Balakrishnan

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Indian inflation continues to march relentlessly upward, crossing 8 per cent for two weeks in a row. Last week’s hike in the administered prices of petroleum products could reflect in the data in the coming weeks. As it is, the passthrough was immediately visible in the prices of daily necessities.

The whole world seems to have run out of ideas. But, of late, central banks are veering round to a consensus that inflation (and inflation expectations) must be kept in check. The US Fed Chairman, Mr Ben Bernanke, cut rates from 5.25 per cent to 2 per cent in a few months in response to the housing and mortgage crises; but he has now decided enough is enough. After all, if interest rates of 2 per cent do not revive growth, what will?

The ECB President, Mr Trichet, is pretty direct – as long as inflation is above limit, he will not relax policy, but raise rates if need be. The rapidly weakening UK economy has not deterred the Bank of England from pausing in its interest rate reduction cycle.

Bonds present a curious picture. Yields are still low (although well above those some weeks ago). Two-year U S Treasuries are below 3 per cent and 10 years barely over 4 per cent - no fear of a surge in inflation here. Is it faith in central banks or the conviction that a weakening global economy will soon drive down commodity prices and inflation?

An immense transfer of incomes from oil and commodity consumers to producers is under way. It is unlikely that the latter will spend all their bounty on buying goods and services from consuming countries whose households will have less left over after more expensive energy eats into their incomes. It is a significant growth-dampening factor on top of the financial and credit mess that the US has gotten into.

It is, therefore, no surprise that the housing and mortgage problems have assumed a back seat in recent days after crude prices skyrocketed. It is clear that subduing inflation and a lasting recovery are functions of the behaviour of the oil market. That is beyond the control of central banks.

The energy price shock is bringing about much-needed, desirable changes in the car-buying habits and life styles of Americans. As it consumes a third of the world’s energy, a US shift to gasoline-saving vehicles has major price implications for oil (even after accounting for China’s and India’s growth). If this happens, it will be testimony to the efficacy of price signals and the market mechanism in energy conservation and efficiency.

More important, it will trigger investments in alternate, renewable energy sources with fewer ill effects on ecology and the environment.