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Why the crisis in Iraq affects you
Financial markets do not like crisis in the world. It is barely a few weeks since the crisis in Ukraine stopped rattling the global markets. Now, a new crisis in Iraq has hit markets around the world.
Here's a look at why it affects India:
Oil prices soar:
Worries over potential rebel attacks on Iraq's oil production units and disruption of supplies pushed oil prices up. For the time being, oil wells, predominantly located in the south of Iraq, have not been attacked and the production has not been affected. However, in case this happens, prices of oil could shoot up dramatically. According to one report, the Indian government expects oil prices to soar to $120 per barrel from $113 currently.
India depends on oil imports heavily. For this reason, any increase in oil price-even a marginal one-could push up India's import bill. This is not good news for India, which has been trying hard to cut down imports and narrow its current account deficit (CAD)-the amount it owes to the world in foreign currency. Moreover, Iraq is India's second largest supplier of oil after Saudi Arabia. In FY14, India purchased around 13% of its total crude oil imports from Iraq. This dependence on Iraq has increased after the US sanctions on Iran over nuclear activities. If oil production in Iraq is hit, it could impact supply to India. This could also have a material impact on the performance of Indian oil refineries which depend on these imports.
The value of the rupee is connected to India's current account deficit. Any increase in the deficit would be a rise in rupee-selling and dollar-buying. This leads to a fall in the rupee. Worries about the impact of a high oil price on India's CAD caused the rupee to fall to Rs 60.55 per dollar, the lowest since April 29 on Tuesday. However, the Reserve Bank of India (RBI) governor, Dr. Raghuram Rajan, reassured investors that India is in a much better position to deal with shocks. The RBI has been shoring up its reserves the last few months by buying dollar whenever the rupee gained.
An increase in oil prices is also bad news for the Indian government. This is because diesel, kerosene and gas are sold to the public at lower rates than the prevailing market rates. This difference between the buying price of oil and the lower selling price is borne by the government. As oil prices rise, the government's subsidy bill also increases. The government is already running a fiscal deficit as its expenditure exceeds its income. A rise in subsidy bill could potentially increase deficits.
The government has been trying to cut fiscal deficit by reducing spending. However, with the economy slowing, it needs to increase productive spending like investment in projects, and cut non-productive expenditure like subsidies. This means the government will increase retail prices of fuel, which could push inflation higher.
Even a marginal increase in oil price has a great impact on the Indian government's finances. According to a Reuters report, a one-dollar rise in the price of oil leads to a $1.3 billion (Rs 7,840 crore) increase in the government's subsidy bill.