The Effect of Falling Oil Prices until 2021

Several consequences are anticipated if oil prices fall in the next five years. The reduction would have an effect on various aspects of the economy, including transportation and industry costs. Even though the drop in oil prices is good news for some, especially importers, it is bad news for exporters due to the decrease in income.
Lowering oil prices is primarily determined by a country's fiscal sensitivity. Lower energy prices would result in a reduction in government income. Lower economy-wide rates lead to a fall in various business earnings. Also, reduction in oil prices will reduce the personal and corporate income tax revenues and EI premiums as well as revenues from sales of goods and services. Also with lower prices the expenses of the government will reduce and this certainly results in a partial offset to the losses from revenue. Some of the spending that are done on statutory programs like benefits to the elderly will decrease. Also, the spending that are linked to the growth in nominal GDP like those of territorial governments will automatically reduce. Saudi has already witnessed the impact of reduced oil prices as the case of 2014 when the budget surplus disappeared. The disappearance is linked to the reduction of oil revenue by 9.7 percent while at the same time the government expenditures ballooning.



Financial Stability Report

From this table, it is worth noting that the graph will progressively curve downwards as is the trend when the surplus reduce and at the same time revenue reduces.

Balance of Payments

If oil prices reduce in the next 5 years, there will be effect on net exports and imports. Decline in oil price will be beneficial to the importers given that the value of oil imports will decline. The reduction in value will reduce the existing account deficit of oil importers. On the other hand, for the oil exporters, the decline in oil prices for the 5-year period will reduce the value of the exports hence lower trade surplus. The effect carries on to the current account of a country especially when they are big importers or exporters of oil.

Often, most of the oil exporting countries rely on tax revenue that accrue from oil to fund the spending in governments hence a bad news. This means that government spending will be largely affected during the time. During the five years, the governments that rely on oil are likely to experience a budget deficit. This means the government will have to increase the taxes or cut on their expenditures.

Inflation and Unemployment

When the oil prices fall, the Short Run Aggregate Supply (SRAS) will shift to the right. The shifting to right results into lower inflation and subsequent rise in the real GDP. If the oil price decline by a unit, the real GDP is likely to increase by a unit. Reduction in oil prices will result in increased unemployment levels in the oil exporting countries.



Social Reaction in General after all the Negative or Positive Impacts

When the oil prices decline the cost of living is likely to reduce. Also, the oil related transport costs will also fall hence leading to lower cost of living and lower rate of inflation. When the real wages are stagnant, the fall in oil prices is significant as it is likely to give the consumers more discretionary income. Reduction in oil prices over this period is like a free tax cut. The fall in oil prices is likely to lead to increased spending on the goods and services and add to real GDP. For the oil exporting countries that highly rely on oil revenues to fund their social spending, a fall in oil prices lead to significant budget deficit and subsequent social problems.



Source: Saudi Arabian Monetary Agency

From the figure above, it will be noted that over the 5 year period, the cost of living will reduce. Most of the sections will witness a reduction in cost of living index given their reliance on fuel. The most noticeable sections will include transport, housing, water, electricity, gas and other fuels sections.

Exchange Rate

Usually, the negative terms of trade shock like a fall in oil prices for an exporter results in reduction of the price of non-traded goods in a domestic economy hence the real exchange rate. Real exchange rate is defined as the relative price of a basket of traded and non-traded goods that is between the domestic and foreign economy. When there is negative oil price shock, wealth is transferred from to importers from the oil exporters. In the long run, noticeably, the 5-years, there will be large shifts in current account balances and portfolio relocation as well. To get the external net financial sustainability of oil importers, the real exchange rate need to depreciate owing to the negative shock that happens to the oil price. This is the only way that non-oil trade balance can be improved.

Monetary and Financial Sector

Oil price decline has several effects in an economy. First, reduction in oil prices results into amplification of credit risk. When the oil prices fall the risk premiums on countries and companies that rely on oil revenue widen. The widening will be reflected in the manner bond spreads, on equity prices and the movement of currencies. Having the fall in the oil prices for a period of years is likely to put at risk the debt servicing capacity of exploration and production firms especially those that have high cost base.







Works Cited

Saudi Arabian Monetary Agency. Inflation Report Fourth Quarter of 2016 (2016): 1-12. Retrieved from http://www.sama.gov.sa/en-US/EconomicReports/InflationReports/Inflation_En_Q4_2016.pdf

Saudi Arabian Monetary Agency. Financial Stability Report (2016):1-57. Retrieved from http://www.sama.gov.sa/en-US/EconomicReports/Financial%20Stability%20Report/FINANCIAL%20STABILITY%20REPORT-2015.pdf



Deadline is approaching?

Wait no more. Let us write you an essay from scratch

Receive Paper In 3 Hours
Calculate the Price
275 words
First order 15%
Total Price:
$38.07 $38.07
Calculating ellipsis
Hire an expert
This discount is valid only for orders of new customer and with the total more than 25$
This sample could have been used by your fellow student... Get your own unique essay on any topic and submit it by the deadline.

Find Out the Cost of Your Paper

Get Price