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Modi’s twin challenge – oil and water

June 29, 2014

Abstract: The Indian economy has remained vulnerable to two exogenous shocks–a rise in crude oil prices and delayed monsoons–which threaten to raise inflation, and increase fiscal and current account deficits. Domestic fragilities greatly exacerbate the impact of these shocks. Though these risks are outside the control of the Indian government, both mitigative measures and structural responses are possible.

Monsoon failure. Monsoon failures are hard to predict early but they significantly contribute to inflation in some food items. Pulses and oilseeds, which are generally grown more in rainfall-dependent regions, are particularly vulnerable. While oil seeds are easy to import, the international market for pulses is thin. One structural solution is to create incentives for farmers to shift cropping lands from cereal to pulses.

Spike in oil prices. The surge in oil prices during international conflicts in oil producing regions has spill-over risks for India’s macroeconomic stability. Prioritizing increased domestic coal production is an important mitigative measure. Fiscally, accelerating closure of the oil subsidy gap should help.

Keywords: external risks; domestic economic fragility; mitigation; structural changes; crude oil; monsoon; oil seeds; pulses

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