Oil Turmoil: Implications for India

For India, a nation where oil accounts for nearly one-third of primary energy consumption and where over 80 percent of oil demand is met through imports, the implications of rising global oil prices are significant. Yet, when it comes to inflation, the direct impact may not be as substantial.

October 03, 2023. By News Bureau

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The resurgence of oil in the headlines cannot be ignored. Brent crude oil prices have risen 30 percent over the last two months crossing USD 95 a barrel mark due to extended supply cuts by Saudi Arabia and Russia. Unlike just a few months ago, when worries about weak demand in the US, EU, and China weighed on market sentiment, the current narrative is dominated by concerns of potential oil supply shortages. Demand for oil from these major economies has proven to be stronger than initially anticipated, and it shows no signs of slowing down. This presents a new challenge for central banks worldwide, which have been grappling with elevated levels of inflation since the previous year. The consequences of higher oil prices loom large, including the likelihood of prolonged inflation and higher interest rates.

For India, a nation where oil accounts for nearly one-third of primary energy consumption and where over 80 percent of oil demand is met through imports, the implications of rising global oil prices are significant. Yet, when it comes to inflation, the direct impact may not be as substantial. Petrol and diesel, which are critical components of India's energy consumption, account for a combined 2.3 percent share in the Consumer Price Index (CPI) basket. Remarkably, retail prices for petrol and diesel have remained unchanged since the summer of 2022. In fact, CPI inflation for petrol and diesel has been at or near zero for the past six months. With general elections on the horizon and concerns about rising food prices, it is unlikely that retail fuel prices will see an upward revision, even if global crude oil prices continue to climb. Thus, the immediate impact of rising crude oil prices on inflation in India is expected to be negligible, though other crude oil-derived products may experience price increases.

However, the scenario takes a different turn when we consider India's current account deficit. As a rule of thumb, every USD 10 increase in crude oil prices can cause the current account deficit to expand by 40-50 basis points. The current account deficit sharply narrowed to USD 1.3 billion (0.2 percent of GDP) in the fourth quarter of fiscal 2023, compared to USD 16.8 billion (2.0 percent of GDP) in the third quarter of fiscal 2023 and USD 13.4 billion (1.6 percent of GDP) in the fourth quarter of fiscal 2022. This improvement was largely driven by an improvement in merchandise trade balance. More recently during the first quarter of fiscal 2024, oil imports are down 19 percent compared to a year ago.

While India is a major buyer of Russian crude, which is currently under sanctions from the US and EU (and cheaply available), any upward movement in global oil prices will adversely affect India's import bill. Reports indicate that despite some Russian crude imports being billed at the USD 60 per barrel price cap, the effective import cost to India is much higher due to increased freight expenses. Any rise in global crude prices will translate into higher freight (to make up for the price cap) and import costs. Furthermore, Russia's extension of production cuts will likely tighten the supply of Russian crude, narrowing the discount compared to Brent.

Natural gas holds a 6 percent share of India's energy consumption, with the fertilizer sector accounting for a significant portion of gas demand, followed by domestic piped gas and CNG for automobiles. Approximately 45 percent of India's gas demand is met through liquefied natural gas (LNG) imports, and the prices of a considerable portion of contracted LNG are linked to crude oil prices. With the surge in crude oil prices, import bill for gas will swell further. While the industry may absorb the increased costs of gas, passing on these expenses to the common man through higher piped gas and CNG prices seems improbable, especially in an election year.

Earlier this year, Oil Marketing Companies (OMCs) reported no under-recoveries from the sale of petrol and diesel when crude oil was below USD 80 per barrel. However, with the ongoing increase in crude oil prices and steady retail fuel prices, this situation is likely to change. OMCs may turn to the government for fiscal support if global oil prices remain elevated. Additionally, the government may consider intervening in the prices of kerosene and CNG, especially in light of the upcoming elections. The government's budgeted allocation of INR 2,257 crores for petroleum subsidy and INR 1.75 lakh crores for fertilizer subsidy in fiscal year 2024 may prove to be inadequate in the face of escalating oil prices.

Amidst all this, the rupee stands to weaken. The Economic Survey's GDP growth forecast of 6.5 percent for fiscal year 2024 is contingent on global crude oil prices remaining below USD 100 per barrel. However, as analysts now predict that crude oil may approach or exceed the USD 100 per barrel mark in 2023, India can only hope for a resurgence of recessionary sentiment and a subsequent cooling-off of oil prices. In these uncertain times, this may be the silver lining amidst the dark clouds that loom over the global economy.

- Anuj Agarwal, Chief Economist and Head of Research, TruBoard Partners