Examining the Linkage between Energy Consumption and Economic Growth in India

By Mallick, Hrushikesh | The Journal of Developing Areas, Fall 2009 | Go to article overview

Examining the Linkage between Energy Consumption and Economic Growth in India


Mallick, Hrushikesh, The Journal of Developing Areas


ABSTRACT

The paper examines whether energy use drives economic growth or vice versa in the Indian context during 1970-71 to 2004-05. Utilizing Granger causality test, the study suggests that it is the economic growth that fuels more demand for both crude oil and electricity consumption and it is the only growth of coal consumption that drives economic growth. When influence of different components of energy on major two components of economic growth is investigated with the same causality test, none of the energy components found to be significantly influencing the two components of economic growth viz. private consumption and investment. In contrast, the variance decomposition analysis of Vector Autoregression (VAR) suggests that there could be a bi-directional influence between electricity consumption and economic growth, other results remaining unchanged. Therefore, the study yields mixed and contradictory result compared to the previous studies in the Indian context. However, on the basis of application of two econometric tools, the study with little more conviction suggests for reducing crude oil and natural gas consumption at least in the consumption sectors, which don't directly contribute to production or add to capital formation of the economy, for achieving higher rate of growth in the economy.

JEL Classifications: C32, E21, O11 & Q43

Keywords: Energy Consumption, Economic Growth, Granger Causality, VAR & India

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

The relationship between use of energy and economic growth has been a subject of greater inquiry as energy is considered to be one of the important driving forces of economic growth in all economies (Pokharel, 2006). In recent years, most of the non-oil producing economies are facing energy deficiencies, as the oil producing economies are unable to meet up the world demand for oil. The supply constraint of energy could be attributed to the frequent geo-political tensions between the nations or natural physical supply constraints in the oil extracting regions1. The increasing world demand for oil,2 leads to frequent escalation in the world oil prices.3 Like shortage of oil, there exists shortage of electricity and other forms of energies viz. natural gas.4 The shortage can significantly affect the consumption and production in the economy. One or the other forms of energy becomes vital to all the sectors of the economy viz. agriculture, industry and services. This energy dependence being common to every sector of the economy justifies the association between energy utilization and the overall economic growth rate in an economy. Hence, any deficiency in supply of oil, natural gas and electricity generations can directly constrain the economic activities, thereby inhibiting the growth rate. The declining supply of these sources of energy not only raises the input prices5 but also influences the prices of other commodities leading to a rise in overall inflation rate and thereby dampening the aggregate demand and growth rate.

It needs to be noted that India domestically meets up 30 percent of its crude oil requirement and the rest is being imported from the oil producing nations6. In India, the transport sector is the principal consumer of petrol and diesel, followed by big and small industrial units. Similarly, electricity consumption share too is the largest by this sector (as shown in Appendix Table 1). India in the past had experienced a huge import bill on account of an increase in the price of crude oils. The inelastic oil demand and rising oil import bill had put pressure on the scarce foreign exchange resources and had also been largely responsible for shortages in energy supply. In the first oil embargo, India.s import bill rose beyond 50 per cent, while the adverse impact of 1990-91 Gulf War caused a huge balance of payment deficit and pushed up the inflation rate to an all-time high of 13 per cent. …

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