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India’s economy hit hard by rising Oil prices

India’s economy hit hard by rising Oil prices

Even as mandarins in the finance ministry made optimistic predictions of a robust GDP growth of over 7% to 8% for the fiscal year 2018-19, India’s economy has been dealt a severe blow in terms of surging oil prices globally.

Even as mandarins in the finance ministry made optimistic predictions of a robust GDP growth of over 7% to 8% for the fiscal year 2018-19, India’s economy has been dealt a severe blow in terms of surging oil prices globally. Every dollar increase in price of crude oil hits two vitals of the Indian economy , the fiscal deficit and the current account deficit ( the difference between import costs and export earnings).

India has more imports than exports which affects the economy. India has huge balance of payments issues with countries such as China , USA and some European countries. With China its reported an astounding US$ 6 billion. One of the reasons why Prime Minister Narendra Modi has been hob knobbing with the Chinese President Xin Ping ostensibly to resolve the Doklam issue but in reality to raise Indian exports to that country.

Judging by the current geo political situation globally, the Syrian conflict, US President Donald Trump walking of the Iran nuclear deal and cancelling the waiver of economic sanctions, dwindling oil production in Venezuela and OPEC cutback in production of 1.2 billion barrels a day, the situation appears grim with oil prices set to breach the US$ 100 mark causing much worries to India’s national oil companies who had earned much when oil prices were around US$ 40 a mark.

At a recent press conference the largest refining and oil company IOCL indicated that fuel prices could go up further as it was difficult to predict how the crude oil supplies from Iran could shrink and impact India’s oil economy, IOCL Chairman and Managing Director Sanjiv Singh had said.

Though profits of IOCL for FY 2017-18 soared to Rs 2,240 crore ,the future appeared uncertain ,Sanjiv Singh said as the short supply of about 6 to 7 million tonnes from iran , which is what India imports from the country, could definitely impact supply demand chain and prices.

“We have not yet received any clear cut directive from the government on the Iran situation, we are working out alternate mechanism for making up the shortfall”, he said. The petroleum ministry also convened a high powered meeting of all the upstream and down stream companies CMDs to find a way out to contain the rising prices which was done only after a reprieve of 15 days for the Karnataka elections to be over so as not to disturb the voters.

India’s oil import bill is expected to jump by a quarter to US$ 87.7 billion in the current fiscal year as of FY 2017-18, due to the surge in international crude prices. For FY 2017-18 imports are pegged at 219.15 MT fr US$ 87.725 billion( over Rs 5.65 lakh crore) , latest data from the oil and gas ministry’s Petroleum Planning Analysis Cell (PPAC) reveals.India imported 213.93 million tonnes (MT) of crude oil 2016-17 for US $70.196 billion or Rs 4.7 lakh crore. India relies more than 80 per cent on imports to meet its oil needs.

Given the global oil scenario of the Syrian conflict and the Venezuelan oil production crisis and OPEC cutback on production of `1.2 million barrels a day, global oil supplies have dwindled drastically pushing up oil prices to a 2013 level when it soared to over 100 USD a barrel. Singh said that if the Iran situation had not erupted then the oil prices would not have soared.

In any cases retail prices of fuel ( petrol and diesel) are mainly driven by international prices of POL ( petroleum products such as petroleum , oil and lubricants). The current geo political situation ( (Syria +iran+opec+Venezuela ) will determine the future oil prices. This seems the best time to bring fuel prices under the ambit of GST to maintain uniform pricing throughout the country. Petrol and diesel are costliest in Maharashtra where the government miscalculated the international scenario and raised excise duties on assumption of prices being stable at 45 US$ a barrel. Petrol is costliest at nearly rs 80 a litre in Maharashtra whereas it’s just around rs 70 to rs 75 a litre.

Let’s look at the larger impact on the economy. The world’s seventh-largest economy, India benefitted most from the sharp decline in crude oil prices between 2013 and 2015. Oil industry experts claim that the entire reduction of about 0.6% of the gross domestic product (GDP) in India’s fiscal deficit between FY14 and FY16 was due to the sharp fall in crude prices. Lower crude prices contributed to the narrower current account deficit. Lower oil price between 2013 and 2015 actually brought twin benefit to India.

While benefit of crude price fall was not really passed onto the fuel consumers in a big way but only in a limited manner, the government retained a large part of the booty by hiking excise duty on retail fuel products, the direct impact on inflation—measured by consumer price index (CPI)—was muted.

Things, however, started reversing about two years ago and have gathered pace in the past few months. As against an average price of $46.2/barrel for the Indian basket of crude oil in FY16, it rose to $56.4/barrel in FY18 and averaged $65/barrel in the fourth quarter of FY18.

With the US’ decision to walk away from the Iran nuclear deal and to re-impose sanctions on Iran, upside risks to crude prices cannot be ruled out. It is then worth understanding the impact of higher crude prices on the Indian economy, Says an expert analyst, Nikhil Gupta, chief economist at Motilal Oswal Securities Ltd. Gupta further adds that one could safely conclude that higher crude prices will adversely affect the twin deficits—fiscal and current account deficit—of the economy, which will have spillover impact on the monetary policy, and consumption and investment behaviour in the economy.

However, before we crunch in numbers, its important to address one tricky question: “what is driving higher crude prices? The question is relevant because the factors leading to change in prices will decide the sustainability of the higher prices.If the rise can be attributed to demand-side factors, it is not necessarily adverse for economic activity or financial markets. The higher crude oil imports bill could be offset by higher oil and non-oil exports (and of course, remittances). Similarly, better domestic economic activity could help meet fiscal deficit targets. However, if oil prices are pushed up by supply factors, it would be a matter of serious concern, opines Gupta.

According to the recent World Economic Outlook (WEO) by the International Monetary Fund (IMF), roughly 80% of the recent oil price increase was caused by deterioration in supply conditions (particularly faster-than-expected deterioration in Venezuelan output).

This, however, is not the only study on the factors leading to higher crude prices. The “Oil Price Dynamics” report published by the Federal Reserve Bank of New York finds that less than two-fifth of the rise in oil prices since the beginning of 2018 was on account of supply-side factors. These contrasting studies lead to uncertainty regarding the sustainability of higher crude prices.

Media reports suggest that not surprisingly then, the majority of the forecasts for oil price remain at $65-70/barrel. An increase of 15-25% in oil prices in one year will impact the Indian economy in various ways.

The Fiscal IMPACT: Its common knowledge in oil industry circles that ,an increase of $10 per barrel in crude prices will lead to an increase of about Rs17,000 crore (or $2.5 billion at an exchange rate of 67/$) in fuel subsidies, equivalent to 0.09% of GDP.

In the Union Budget 2018-19, the government had budgeted for petroleum subsidy of Rs25,000 crore, similar to that in FY18. Economists calculate that that fuel subsidy could be as high as Rs54,000 crore if crude price averages $65/barrel in FY19.

Additionally, a cut of Re1 in excise duty for both petrol and diesel will lead to an annual revenue loss of Rs12,000-13,000 crore (or 0.065% of GDP). Will government resist an excise duty cut considering that the general election is less than a year away now is a big question. Any increase has to be now and not later.

The Current Account Deficit impact: Generally, an increase of $10 per barrel in crude oil prices will lead to an adverse impact of $10-11 billion (or 0.4% of GDP) on current account deficit. There are two opposite forces at work in current account deficit. “Higher oil prices will push the import bill higher; however, it will be partly offset by higher oil exports and better remittances. The latter will materialize, since more than half of India’s remittances are reported to be channelled through the Gulf countries, which are likely to witness better economic conditions with higher oil prices”, says Gupta. Number crunching will show that, an increase of $10 per barrel in crude prices will push the merchandise imports bill up by about $20 billion, which will be partly offset by an increase of about $6 billion in oil exports and $3-4 billion in workers’ remittances.

With a weightage of only 2.4% in headline CPI, will there be an adverse impact? It will depend on how the oil companies are allowed by the government to pass on the higher crude oil prices to the consumers. As general elections are impending in 2019, it is difficult to say if there is going to be a significant hike in retail fuel prices, and thus, the direct impact on CPI inflation is likely to remain muted.Overall, the windfall gains—in terms of lower subsidy and higher revenue for the government, and lower imports—from lower crude prices are behind us or literally wiped out for the national oil companies, economists claim.

T N Ashok is a Corporate Consultant, Resident Editor and Writer of Economic Affairs.

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