How high crude oil prices and Iran dilemma will impact India

Publish Date: September 07, 2018

India finds itself in an oily situation. For a country that needs to import more than 80% of its oil requirements, it isn’t surprising. Blame it on the rising crude oil prices. As against an average price of $46 per barrel in FY2016, the crude prices are currently hovering around the $76/barrel mark and is expected to reach the $86-mark over the medium-term, according to our analysis.

The US’ sanctions on Iran is a double whammy. This week, two high-level American diplomats flew to New Delhi to ensure that India doesn’t import oil from Iran from November 4. If India does acquiesce to US’ demands, the crude prices in India may go up further. The reason? Importing crude oil from Iran is much cheaper as New Delhi found a way to pay in rupees and through barter. But a snap in ties could bite India as it would have to import oil from another country in US dollars.

We also must remember that rising crude prices from the demand side is not necessarily a bad thing. That’s because higher oil exports and higher remittances, especially from the Gulf countries, can soften the blow. But supply-side factors can be disconcerting for an economy that relies heavily on oil imports. US sanctions on Iran, production slowdown in Venezuela and lower output in Libya means that oil production has taken a beating in the last few months. The recent evacuation of Gulf of Mexico rigs in the wake of a hurricane alert has also nudged the oil prices upwards. Although the OPEC countries have upscaled their capacity, they will find it tough to fill the production gap.

Related read: 6 effects of rising crude oil prices on India

With crude prices may range in the $70-80 mark in the near future, let’s look at what impact it will have on the Indian economy.

1) Fiscal deficit

Until recently, India was on track to balance its books for the first time in 11 years. The country met its fiscal deficit target of 3.3% of the GDP this quarter because it spent less on fuel subsidies. However, the uptick in crude prices threatens to derail the good work as the rule of thumb is that a $10 per barrel jump in crude prices can shave of 0.40% of India’s GDP.

Last week, credit rating agency Moody’s opined that the rising crude prices would add to the country’s short-term fiscal pressures. It also felt that the the fiscal target of 3.3% would be breached this year due to high crude prices. The fiscal slippage, it said, may force the government to cut back on its capital expenditure but that would have an impact on our consumption and investment patterns.

Moody’s also believes that the petroleum subsidies can be a migraine for the Indian economy. If the high crude prices persist, the subsidies may amount to $7.7 billion as against the current year’s budget of $3.6 billion.

2) Current account deficit

The current deficit deficit — the difference between value of imports and value of exports — is likely to hit 2.6-2.8% of the GDP this year, primarily led by a higher oil import bill. India’s oil import numbers have risen consistently for the last three years and a further increase in the data would stretch the CAD further. India now imports 5 billion barrels per day, overtaking Japan as the third-highest oil importer in the world. Only China and the US import higher barrels than India.

Analysts at Nomura believe that $10 increase in crude oil prices knocks off about $10-11 billion (0.4% of India’s GDP) on India’s current account deficit. The math is simple. The higher the crude price, the higher the import bill is. And a higher import bill can only strain a country’s balance of payment.

3) Inflation

A State Bank of India (SBI) research suggests that a $10 increase in crude prices pushes the inflation rate by 30 basis points. Inflation generally goes up when oil prices go north. That’s because oil is a vital input in any economy. It is even more crucial for countries like India because it imports more than 80% of its requirements.

The recent oil price surge means that the wholesale inflation has hit a four-and-a-half year high of 5.77% and the retail inflation has increased to 5%, a five-month high.

Even the Indian government has admitted that the high crude prices are a bane of the Indian economy. Oil minister Dharmendra Pradhan told Bloomberg in April that the government would be happy if the prices traded around the $50 per barrel mark.

Higher inflation is bad news for the government, considering the country is heading for the general elections next year. Analysts reckon the inflation trends may remain subdued until the elections are over as the government may be arm-twisted to reduce excise duty or re-introduce the cap on fuel price.

4) Stock markets

Many studies indicate that oil prices and stock markets have an inverse relationship. That’s because higher crude prices do impact the profitability of businesses as domestic demand falters and exchange rate takes a hit.

Since January 2017, crude prices have increased by more than 30%, which led to a significant sell-off in the small- and mid-cap sections in May 2018. While the small-cap index shed 36%, the mid-cap index slumped by 8% in that period. While rising crude prices was not the sole reason for the May meltdown, it did play a role in stifling the stock market.

Related read: It is ‘MayDay’ in the Indian mid-caps this 2018

The companies that are most affected when crude prices go up are refining, airline, logistics, tires, plastic, paints and fertilizers. Basically, any company that relies on oil as a major input is impacted at such times.

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