How Does WTI Crude Oil Affect Economic Growth of India?

Sciknow Publications Ltd. AEBR 2014, 1(4):94-98 Applied Economics and Business Review DOI: 10.12966/aber.10.02.2014 Attribution 3.0 Unported (CC BY 3.0) How Does WTI Crude Oil Affect Economic Growth of India? Amalendu Bhunia * Associate Professor, Department of Commerce University of Kalyani, West Bengal, India *Corresponding author (Email: bhunia.amalendu@gmail.com) Abstract - The present study examines the impact of WTI crude oil price on economic growth of India for the periods between 1991 and 2013 based on time series yearly secondary data obtained from Index Mundi datanase and Reserve Bank of India database with the application of financial econometrics. In other words, this study intends to examine how WTI crude oil price affects the economic growth of India. Because of high quality and light weight World Texas Intermediaries crude oil by India as well as disruption of crude oil imports from Iran recently WTI crude oil prices has been increased significantly for which India s import bill and trade deficit has been increased drastically, as a result the rupee has depreciated progressively, foreign flows withdraw, high inflation rate and the economic growth of India has been reduced. The empirical results illustrate that in the long run India s real GDP growth is affected by WTI crude oil price in the midst of long-run real interest rates and inflation rates of India. Keywords - WTI crude oil, Real GDP growth rate, Inflation rate, Real interest rate, India, Cointegration test 1. Introduction In the direction of identify the present economic state of affairs in India, it facilitates on the way to keep in mind what occurred in 1991. The economic crisis in India was created because of increasing foreign debts, continuous increase in import bill on account of crude oil imports, trade disturbances with Gulf countries and high inflation etc. But in the past two decades, the Indian economy has developed remarkably with an average annual rate of 6.4 percent even after the global economic crisis. Between 2002 and 2011 India s average annual growth rate was 7.7 percent, just near about the China (Subramanian, 2013). As said by Business Insider, India s growth rate was below 5 percent in the fiscal year ending March 31, 2013, as well below the previous fiscal year. Then question obviously arises, why, how and for what Indian economy facing problems? Most of the researches (Kumar, 2009; Akram and Mortazavi, 2011) affirm that Indian economy has been faltering due to high current account deficit, low foreign inflows, permanent amplify in import bill as a result of crude oil imports, disruption of crude oil imports from Iran, high inflation rate, balance of payments worsening, high levels of debt, huge budget deficit, etc. India is one of the important importing countries for high quality and light weight World Texas Intermediaries crude oil. However, recently disruption of crude oil imports from Iran prolong to push oil prices elevated, growing oil prices has insinuation on the import bill in India, increasing import bill has inference on the trade deficit and in this manner the currency, ultimately hit the inflation. For this reason, India s trade deficit has been increased significantly, when foreign flows withdraw, the rupee has depreciated steadily and the economic growth of India has been reduced. During April 2013, India s import bill was increased by 41 percent only because of importing crude oil that was one-third of India s total import bill (Vini, 2013). It is expected that both enhances in demand as well as panics of supply interruptions have exercised growing anxiety on crude oil prices. Since two important developing countries China and India have been budding speedily because of their quick industrialization and urbanization, automatically the demand of international crude oil has been increased steadily. Besides, the fears of supply disruption of crude oil from Iran, Iraq, Nigeria, Venezuela etc. have increased oil prices as well (Brown, 2012). Basically, crude oil price increase affects the business and thereby affects the household sector via petroleum products, cost of transportation, manufacturing cost, heating cost and prices of the products or services too. It is usually boost the inflation and decrease the economic growth in India. In the face of causes on crude oil supply and demand, the association between rising crude price and economic recessions in the U.S. is not ideal. Nevertheless, last five U.S. depressions were leaded by significant augments in crude prices (Sill, 2007). Then, it is very clear that the import of crude oil price affects the Indian economy. As a result, to find out whether the association between international crude oil prices and GDP growth has really distorted over time, it is obligatory to surpass cointegration investigation along with attract

Applied Economics and Business Review (2014) 94-98 95 econometric analysis. 2. Oil Price and GDP Growth In recent times, possibilities of a spear in oil prices have increased owing to the threat of disruptions due to increasing unrest and geopolitical tensions in the Middle East and North Africa. Prearranged these intensifying anxieties, three oil price situations are measured to demonstrate potential shocks on the global economy pretend with the GEM, which is a six-region general equilibrium model of the world economy. The first situation is a short-lived oil production interruption whereby oil prices spike 10 to 20 percent for a few weeks. This has only a small impact on the global economy. A larger production interruption presumes so as to the Syria divergence overruns such as through stumbling Iraqi oil exports. Saudi Arabia s standby capability gives back, however in the midst of a wrap in addition to probably eminence matters arising trusting the grades lost. This second state of affairs a bigger interruption wherever oil prices spine to $150 a barrel for two quarters thinks that the global oil market unmoving purposes proficiently through higher price. On the other hand, it shrinks global growth by 0.13 percentage points in 2014 and elevates additional menaces. In the third situation specified the current intricacies for the global economy the same $150 a barrel price pierce is escorted by larger unfavorable outcomes taking place buoyancy, in the midst of capital moving back to safe havens as well as a unrelenting turn down in equity prices. In this case, the shock on global growth will be greatly bigger concerning 0.5 percentage points lower in 2014. Contemporary developments recognize a fairly move forward accentuated propensity of humanizing OECD economies simultaneously seeing that capable economies extend to decelerate. The stipulation in capable economies has developed into immobile further aggravated ensuing to the contemporary decline in their switches. Consequently, even if the 2014 GDP growth envisage for the OECD has been customized stirring from 1.9 per cent to 2 per cent, China s growth principle has been subordinated to 7.7 per cent from 7.8 per cent, in fondle with its 2013 GDP growth passion. India has experienced plentiful progresses of late and the 2014 GDP growth foretells lingers at 4.7 per cent for 2013 and 5.6 per cent for 2014. 3. Literature Review The appraisal of the dissimilar precedent revision can offer suggestion intended for indulgent the circumstances along with decision on the unlike argument through which the investigator intricate the result in the midst of rational reckoning. An empirical study of Zhang (2008) examined the association between oil price and GDP growth of Japan based on quarterly time series data with the application of econometric tools. He illustrated that there was a negative association exist between oil price and GDP growth of Japan. Hsieh (2008) observed the influence of crude oil price on GDP growth in Korea based on time series data by using econometric tools. He confirmed that that there was a negative association exist between crude oil price and GDP growth of Republic Korea. Kilian (2009) squabbled that the basis of the crude oil price augment is imperative through increase of brawny worldwide demand showing toward encompass further benevolent inferences in support of U.S. real GDP growth than crude oil price boosts to facilitate effect from scarcities of supply. Another important study made by Carlton (2010) examined the connection between oil price and GDP growth of US based on the findings of the previous studies and illustrated that there was a non-linear negative association subsist between oil price and GDP growth of US. Dogrul and Soytas (2010) investigated the association between oil price changes, interest rate, economic activity and employment of the emerging markets for the period between 2005 (January) and 2009 (August) using time series data with the application of Toda-Yamamoto method. They illustrated that the real price of oil and interest rate perk up predicts of unemployment in the long run and prop ups the hypothesis that labour is an alternative issue of production for capital and energy. Akram and Mortazavi (2011) investigated the impact of the change in crude oil price on the GDP growth of India, Pakistan and Bangladesh based on yearly time series data with the application of multivariate VAR, Granger causality test and impulse response function test. The empirical results confirm that crude oil price and GDP growth are negatively associated and in case of India, when crude oil price decreases GDP growth is remarkably affected. Kilian and Vigfusson (2012) investigated the forecasting association between oil price and U.S. real GDP based on time series data between 1974 and 2011 using econometrics. They showed that oil price is not useful for US real GDP under the study. Roach (2013) observed a structural investigation of oil price impact on the macroeconomic variables in Jamaica based on time series data between 1974 and 2012 using regression model. The results demonstrate that oil price movements have been significantly affected the macroeconomic variables of Jamaica. Ebrahim et al (2014) examined the influence of oil price unpredictability on some macroeconomic variables. The behavioral study illustrated that unpredictability has numerous damaging and destabilizing macroeconomic influences which affect a fundamental barrier to future sustainable economic growth if it is not checked. The convincing totting up of the above fair assessment of pertinent text fashioned turn over engagement on the accessible topic exposes extensive opportunity for the legitimacy as well as instigates of this effort and reproduces a

96 Applied Economics and Business Review (2014) 94-98 number of important confirmations that confirm its feasibility, seeing that possibly noticeable here it. Nor has one earlier study observed the influence of WTI crude oil price on economic growth of India with considering long-term real interest rates and inflation rates. 4. Material and Methods 4.1. Data source The present research work is maintained an enormous covenant on secondary data collected from Index mundi database and RBI (Reserve Bank of India) database for the period between 1991 and 2013. The justification for restrictive this research work is delimited as a consequence of economic reforms for the first time in India, on one side and the availability of the most recent yearly data, on the other. 4.2. Sample design and variables used This research work reflects yearly data in the order of the international crude oil price, inflation rate, long-term real interest rates and real GDP growth rate in India with a number Table 1. Descriptive Statistics of 23 observations. Subsequently, the raw data has been converted into natural log for maintaining the data regular. Eviews 8.0 package program has been worked out for assembling the data and carrying out of empirical study. 4.3. Tools used All the way through testing of the present research work, statistics include descriptive statistics, econometric tools include Augmented Dickey Fuller both at levels and 1st differences and Johansen cointegration test have been designed. 4.4. Descriptive statistics To build the investigation as well as explanation more clear-cut and perfect, the descriptive statistics have been computed from the natural log values of international crude oil price (LCOP), Indian real GDP growth rate (LRGDP), inflation rates (LIR) and long-term real interest rates (LLRIR). Descriptive statistics illustrates that mean and variance changes with time and none of the series are normally distributed. LCOP LRGDP LIR LLRIR Mean 3.752569 1.809403 1.599789 2.198773 Median 3.556776 1.900614 1.408545 2.183802 Maximum 4.590868 2.258633 2.625393 2.564949 Minimum 2.833801 0.357674 0.940007 1.682688 Std. Dev. 0.531318 0.416775 0.544054 0.248733 Skewness 0.225692-1.838095 0.585114-0.390464 Kurtosis 1.729154 7.364715 1.934833 2.368869 Jarque-Bera 1.743012 31.20823 2.399683 0.966167 Probability 0.418321 0.000000 0.301242 0.466878 Observations 23 23 23 23 5. Results and Analysis 5.1. Unit root test results Johansen cointegration test is applicable if the time series data are stationary. With the rationale of stationarity test, Augmented Dickey-Fuller unit root test is utilized with the levels and first differences of both the series under the study lying on the condition so as to the null hypothesis is stationary, as a result optimistic reaction of the unit root hypothesis preserves stationarity. Unit root test results are revealed in table-2 in an attempt to delineations that LRGDP are stationary at levels as well as 1 st difference. On the other hand, results confirm that the LCOP, LIR and LLRIR are stationary at 1st difference [1(1)]. Augmented Dickey Fuller unit root test tells that inaccuracies have unwavering variation and are statistically autonomous.

Applied Economics and Business Review (2014) 94-98 97 Table 2. ADF Unit Root Test Result At level At 1 st Difference LCOP -0.562987 (Non-stationary) -4.731341 (Stationary) LRGDP -5.707142 (Stationary) -7.348037 (Stationary) LIR -1.714831 (Non-stationary) -4.560293 (Stationary) LLRIR -1.826115 (Non-stationary) -3.923523 (Stationary) 1% level 5% level 10% level 5.2. Johansen cointegration test results Johansen cointegration test has been used to test the long-run relationship among the four series under the study. Since the preferred series are stationary, long-run relationship can easily be illustrated by using cointegration test. In the present research work, linear deterministic trend has been assumed to deduce how these deterministic factors are really integrated in Critical Values -3.769597-3.004861-2.642242 Table 3. Johansen Cointegration Test Result Unrestricted Cointegration Rank Test (Trace) Hypothesized Trace 0.05-3.808546-3.020686-2.650413 the representations. In this test, lags interval in first differences 1 to 1 have been considered on the theory that Johansen s co-integration test is insightful to the lag lengths exercised in the VAR models (Stock and Watson, 1993). Again, Luutkepohl and Saikkonen (2000) recommend an additional resourceful inference method of the deterministic factors on condition that the linear trend can be alleged to be at largely linear and not quadratic. No. of CE(s) Eigenvalue Statistic Critical Value Prob.** None * 0.645347 56.67184 47.85613 0.0060 At most 1 * 0.571631 34.90293 29.79707 0.0118 At most 2 * 0.417759 17.09977 15.49471 0.0284 At most 3 * 0.239215 5.741481 3.841466 0.0166 Trace test indicates 4 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Unrestricted Cointegration Rank Test (Maximum Eigenvalue) Hypothesized Max-Eigen 0.05 No. of CE(s) Eigenvalue Statistic Critical Value Prob.** None* 0.645347 21.76891 27.58434 0.0325 At most 1* 0.571631 17.80316 21.13162 0.0374 At most 2* 0.417759 11.35829 14.26460 0.0371 At most 3 * 0.239215 5.741481 3.841466 0.0166 Max-eigenvalue test indicates 4 cointegration at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Cointegration test results have been revealed in table-3. There are two test statistics for co-integration, the maximum-eigen value statistics and the trace statistics. The maximum-eigen value test statistic tests the null hypothesis of four cointegrating vectors and the trace statistic, conversely, tests the null hypothesis of four cointegrating vector against a

98 Applied Economics and Business Review (2014) 94-98 general alternative of one or more cointegrating vectors at the 0.05 level. Table-3 divulges the cointegration test results suggests surety concerning association between LRGDP, LCOP, LIR and LLRIR in the long-run as trace statistics is more than critical value in case of both the likelihood ratio test. This test as well recognized four cointegration vectors. It is additionally signifying that four widespread stochastic trends or an extent of market assimilation are present there, as supported in, (Bhunia and Pakira, 2014). 6. Conclusions The effects of WTI crude oil shocks on the economic growth of India would be survived if WTI crude oil price is significantly related with the GDP growth rate of India during the study period. The preferred time series data are stationary that is a signal of the cointegration test as well as to determine the association among the four variables in the long period. The empirical results of cointegration technique during Johansen test talk about that confined cointegration association among the preferred variables in the present study are significantly present in the long run that corroborates that India s real GDP growth is persuaded by WTI crude oil price after considering long-run real interest rates and inflation rates of India. It is essential toward think about the background wherein WTI crude oil price revolutionizes have effect, prominence particularly that a prearranged crude oil price transform has a superior shock in a situation of until that time unwavering prices than in one of unpredictable market activities. This study is not free from few limitations. Bivariate cointegration association among four macroeconomic variables is not considered in the present study. If it is considered, the influences of crude oil price on real interest rate and inflation rate may easily be determined. 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