Model Answer

Imported inflation occurs when rising prices of imported goods and inputs increase domestic prices. India is particularly vulnerable because it imports over 85% of its crude oil requirement.

How Oil Shock Causes Imported Inflation

1. Fuel prices rise with higher global crude prices.
2. Transport costs increase across the economy. e.g: Higher diesel costs raise freight charges.
3. Production costs rise for energy-intensive industries. e.g: Cement, steel and chemicals.
4. Food prices increase through higher transportation and input costs.
5. Rupee depreciation can make crude imports even more expensive.
6. Inflation expectations may trigger wider price increases. e.g: RBI estimates a 10% crude-price rise can raise headline inflation by around 20 basis points.

Way Forward

1. Diversify crude-oil suppliers and maintain strategic petroleum reserves.
2. Reduce oil dependence through EVs, renewables and public transport.
3. Use calibrated fuel taxes to moderate extreme price shocks.
4. Maintain prudent monetary and fiscal responses.

Oil shocks transmit global inflation into India through fuel, transport and production costs. Reducing import dependence is therefore essential for long-term price stability.