Impact of Oil Price Fluctuations on Indian Economy

Abstract

Indian economy has been facing the twin issues of mounting trade imbalance and persisting inflation. Oil constitutes one-third of the country's total imports and is considered to have wide-ranging impact on its economy. This paper empirically examines how oil price fluctuations impact Indian economy through various channels, viz. real sector, monetary policy, external trade, exchange rate and investment. The results of cyclical correlation analysis suggest that oil is pro-cyclical to output, price level, stock market, gold, interest rate and foreign exchange reserves, while it is counter-cyclical to money supply, net exports and exchange rate. Also, it is found that oil Granger causes output, general price level and net exports. The study employs vector auto-regression (VAR) analysis and examines variance decomposition to capture the linear inter-dependencies among the variables. The structural stability tests demonstrate that there is no evidence of structural break in the VAR model, confirming the reliability of estimated relationships under the VAR model.