Falling Crude Oil Prices And Its Effect On Indian Economy.

Crude oil prices are falling to new lows and for reasons speculated include the economics of demand and supply to the regional geopolitics in the Middle East and the possible strategic implications on the economy of Russian Federation embroiled in a cold conflict with the west in Ukraine. Whatever the reasons be, it remains obvious is that crude oil prices have fallen, are likely to fall further and possibly remain at such low levels at least for some time in 2015 before the trend reverses. Obviously, the falling crude prices are a catalyst to net oil importers such as China, Japan and India. For an economy like India, plagued by twin – fiscal and current account – deficits and a declining economic growth, this is a god-send opportunity.

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Fiscal Deficit

The falling crude oil prices have given the opportunity to the Indian government to effectively move from an administered price of fuels to market-determined prices and rationalize fuel subsidies substantially. While partially reducing the pump prices, the government has also raised excise duties on fuels to shore up any shortfall in tax revenues. However, the revenues of the constituent state governments who levy an ad valorem Sales Tax on fossil fuels, budgeted on high oil prices, are likely to fall short unless such taxes are also raised, which is yet to happen across the map. Further, it remains to be seen, whether the Indian government will be able to hold on to the additional levies, in case the crude oil prices increase.

Current Account Deficit

India’s current account deficit in the third quarter of 2014 is around USD 10.10 billion up from around USD 7.83 billion in the preceding quarter (Source. Reserve Bank of India) For a country, which imports more than 77.6 percent of the crude oil it requires, a substantial drop of more than 50 percent should have been a great catalyst for the economy as well as its perennial problem of an adverse current account deficit.

Since, petroleum and oil imports account for 34.4% of India’s total imports, the rumor around is that if crude stays below USD 50 in 2015, India’s oil import bill could fall by USD 50 billion in 2015, eliminating India’s current account deficit. However, the gains of a lower crude oil prices on current account deficit, though positive are likely to be muted and not translate to such exponential sums in absolute terms.

In recent years, India has emerged as one of the biggest exporters of refined petroleum and petrochemicals in Asia, which accounts for around 19.4 percent of India’s total exports. This is directly linked to international crude oil prices and hence we must also expect a substantial fall in export revenues on this count.

Middle East is also an important trading partner of India, accounting for over 20% of India’s merchandise exports. Middle East also accounts for around USD 35 billion in remittances which amounts to around 55 percent of USD 63 billion India receives from expatriate workers. Since, crude oil is the dominant source of revenue for the ‘welfare’ state and the public in the Middle East, any pronounced slowdown in Middle East coupled with reduced government spending on infrastructure there, on account of falling crude oil prices will boomerang on the Indian economy.

Inflation and Economic Growth

Inflation has subsided largely due to a fall in fuel prices with the benchmark wholesale price index falling to record lows of less than one percent. The government is slowly emerging from a policy paralysis and the sentiments are upbeat, yet the economy has not really taken off and the economic growth has also been subdued at 5.30 percent. Whilst it would be too early to blame the government, most of the proposed economic reforms are yet to see any impact on the ground.

Channeling savings

The general trend with Indian households is to invest a substantial part of their savings in gold and silver. The fruits of lower crude oil prices will not accrue to Indian economy unless the additional savings are channeled into the productive sectors of the economy. Substituting crude oil for gold as the dragger for balance of payments should be the real cause of concern for the managers of the economy.

Cyclical trends in crude oil price

The cyclical trends in crude oil price are but obvious. Crude has fallen to lows of USD 10 in 1998-99 during the Asian financial crisis and to lows of USD 40 in 2009 during the global financial crisis only to hit new highs thereafter. The Indian economy continues to be vulnerable to a rise in crude oil prices. Rather than speculating, if and when will the trends in crude oil price reverse, it would be more prudent to shore up domestic production of crude oil to act as a long-term hedge by ironing out the implementation issues in the National Exploration Licensing Policy (NELP). In the short-to-medium term, there is a case for aggressively building up strategic petroleum reserves as well as securing crude oil supplies by investments in under-production exploration blocks.

Conclusion

The new Indian government has had a golden opportunity in falling crude prices knocking its doors. It is incumbent upon them, to make the most out of it with accelerated economic reforms and translate this into high growth. If crude oil prices remain below USD 60 in 2015 and the Indian government is able to accelerate by substantial measure the pace of economic reforms, Indian economy will be the hot spot to watch out for in the global emerging markets.

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Petroleum Import – Export Data Source : Petroleum Planning and Analysis Cell (PPAC) RR – December 2014

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2 thoughts on “Falling Crude Oil Prices And Its Effect On Indian Economy.

  1. Pingback: Oil at 60, what’s in store for India? - PGurus

  2. Pingback: The downside impact of Rupee depreciation on ‘Make-in-India’ - a perspective - PGurus

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