Oil Remains Perennial Cause Of Trouble For India

The current US-Israel attack on Iran in February has all but thrown India into another crisis. Iran’s blockage of the Strait of Hormuz, Israel’s bombing of Tehran’s gas fields and Iran’s retaliatory fire on Arab oil and gas facilities have pushed the world into a totally uncharted territory.

If West Asia continues on a mutually destructive agenda, India will face a multisectoral crisis, which is largely emanating from its dependence on imported fuel. It also highlights a dire need for India to free itself from energy dependence. For this, India needs to assess the threat and introduce urgent reforms to achieve energy independence to prevent history from repeating time and again.

In the first two decades of free India — in the 1950s and most part of 1960s — crude oil was never a problem for India, for its price was artificially kept low at $1.80 per barrel by seven multinational oil companies. As one could buy a US dollar for Rs 4.76 during these 20 years, coupled with lower vehicle ownership in the country, India had no problem footing the oil import bill.

The first blackmail by the oil countries began in 1967. The crisis began after Egypt closed the Strait of Tiran for Israeli ships for the second time after the 1956 Suez Crisis. Israel responded with attacks on the three-nation Arab coalition comprising Egypt, Syria and Jordan. The war that lasted for six days ended with the defeat of the Arab coalition. However, it sowed the seeds of weaponisation of crude oil, with Arab countries imposing an oil embargo on countries supporting Israel.

India had devalued the rupee by 57.5 per cent under pressure from the World Bank and the International Monetary Fund (IMF) in June 1966, from Rs 4.76 to Rs 7.50 per US dollar. The move was expected to enhance the country’s export competitiveness.

However, the war led to the closure of the Suez Canal for eight long years, which increased trade costs for India. A spike in freight cost — caused by the oil crisis and the Suez blockage — eroded India’s export competitiveness and increased the cost of food imports, forcing India to avail $90 million loan from the IMF for the first time under the Compensatory Financing Facility (CFF), a specific type of low-conditionality loan for countries facing temporary export shortfalls or commodity price shocks.

Another crisis came after six years. Egypt and Syria launched a surprise attack on Israel during the Jewish holy day of Yom Kippur on October 6, 1973, to reclaim the Sinai Peninsula and Golan Heights, which they lost in the 1967 Arab-Israeli War. While the Soviet Union supplied arms to Arab nations, the US backed Israel with full support.

During the war, Arab oil-producing nations met in Kuwait under the banner of the Organization of Arab Petroleum Exporting Countries. They decided to use oil as a weapon, coordinated production cuts, and, alongside the broader OPEC, ended the oil monopoly of the seven Western oil companies. This caused the global crude price to quadruple from roughly $3 a barrel in 1973 to $12 a barrel in 1974.

The sudden 300 per cent increase in oil costs drained foreign exchange reserves almost instantly. It also increased the cost of fertilisers, leading to a spike in food prices. Severe drought in 1974 and 1975 resulted in lower domestic food production. The Suez blockage and higher freight costs increased the cost of imported food.

The overall impact led to inflation rising to an astounding 28 per cent in 1974, leading to student protests in Gujarat against food prices under the Navnirman Movement. The Gujarat protests found resonance in Patna, where students protested against an increase in hostel mess bill. Protests in Gujarat and Bihar brought veteran leaders Morarji Desai and Jayaprakash Narayan to the centre stage as the rallying figures of opposition. The subsequent Allahabad High Court disqualifying then Prime Minister Indira Gandhi, resulted in the imposition of the National Emergency.

Within five years, the third oil shock occurred in 1979, when the Islamic revolution swept Iran. This led to a massive drop in oil production, more than doubling the crude oil price from $13 to over $35 per barrel.

1979 saw one of the worst droughts in decades. Agricultural production fell by about 10 per cent, and foodgrain output dropped by nearly 14 million tonnes. The cost of domestic food production increased because of higher fertiliser prices, while the prices of imported food surged due to freight costs. The sudden supply constraints, such as food and energy, triggered massive inflation, which rose by 19.9 per cent.

Unlike the 1973 shock, India was now more industrialised and more dependent on oil for transport. So the impact of the oil shock was more pronounced compared to the 1967 and 1973 crises. The import bill surged by 29 per cent from around Rs 6,814 crore in 1978 to Rs 8,795 crore. Trade deficit ballooned from Rs 1,088 crore in 1978 to Rs 2,368 crore in 1979.

Infrastructure bottlenecks in power, coal and railways, combined with the oil shock and drought, deepened the slowdown. Power shortages were so severe that industrial production declined by 1.4 per cent, a rare occurrence in post-independence India.

The Janata Party government led by Morarji Desai, which benefited from the 1973 oil shock, fell following internal squabbles and the economic crisis triggered by the 1979 oil shock.

When Indira Gandhi became Prime Minister once again in 1980. The 1979 Iranian Revolution and the 1980 Iran-Iraq War made the country’s economic situation precarious, forcing the Congress government to approach the IMF in 1981 for a $5.8 billion Extended Fund Facility, which was the largest loan in the fund’s history at that time.

However, unlike the 1967 compensatory drawing, the 1981 IMF loan was a structural adjustment loan, which came with many conditions such as easing some import restrictions, encouraging exports, and a subtle shift away from the "License Raj." Many economists argue that the "seeds of 1991 Liberalisation" were sown with this loan.

By 1986, crude oil price declined to around $15, thanks to the glut created by Saudi Arabia. Riyadh’s decision to produce surplus oil could be attributed to various factors — overproduction by Nigeria and Venezuela, intent to penalise Shia-dominated Iran, which was fighting Sunni-dominated Iraq and weakening revenue flow of the Soviet Union.

The bottom-low crude oil price and self-sufficiency achieved by the Green Revolution provided a honeymoon period to the Rajiv Gandhi government. Under the New Economic Policy (1985–1989), Rajiv Gandhi reduced duties on computers and telecommunications equipment, laying the foundation for India’s future IT sector.

Instead of a license for a specific product, companies were given "broad-band" licenses to produce any vehicle in that category. This allowed companies like Maruti Suzuki and Hero Honda to thrive. The 1985 budget, presented by finance minister V.P. Singh, lowered corporate and personal income tax rates to encourage compliance and investment. In 1986, V.P. Singh introduced the single most important excise reform of the decade Modified Value Added Tax (MODVAT), arguably in post-independence history until the GST, which spurred the industrialisation in the country.

The next crisis came four years later in 1990, when a heavily indebted Iraq invaded debtor Kuwait, which refused to write off debts and increased oil production, keeping oil prices low in 1989. The war resulted in the oil prices doubling to over $40 a barrel. It disrupted foreign remittances from the Gulf and surged import bills, leading to the Balance of Payments crisis in 1991. India pledged gold to the Bank of England to overcome the crisis.

The new Congress government under prime minister P.V. Narasimha Rao, which inherited only two weeks of forex reserves by mid-1991, liberalised the economy by abolishing License Raj, firmly establishing India on the path of economic reforms.

The oil price has also helped India sometimes. The Asian Financial Crisis crashed the crude oil price to $10, which unintentionally helped India navigate through Western sanctions imposed after the country detonated nuclear devices in 1998.

In 2013, higher oil prices coupled with US taper tantrums led to rupee depreciation, depletion of forex reserves, and stock market crashes — making the country end up in the Fragile Five club. The crisis led to the defeat of the incumbent UPA government and the installation of the Narendra Modi-led BJP government. The crude oil price began a downward trend in 2014 and fell to $28 a barrel, helping the Narendra Modi government to put the economy back on track

The crude oil market once again began to boil in 2022, when Russia invaded Ukraine. The price shot up to over $120 a barrel. Though the price eased, Hamas’ attack on Israel and Tel Aviv’s retaliation in Gaza in 2023 spiked prices again, but India managed to tide over the crisis by buying cheaper Russian oil.