Higher Oil Prices: Diminished Risk To India’s Twin Deficits?

A surge in prices, particularly for an oil importer like India, can mean wider current account and fiscal deficits, elevated inflation and weaker growth. However, the degree to which a surge in oil prices will hurt India’s key economic indicators will be more modest than in the past, economists that BloombergQuint spoke with said.

On Monday, Brent crude oil prices rose past $70 per barrel for the first time since May 2019. Prices have risen by over $10 per barrel since the start of the third quarter.

The Oil Math: Fiscal Deficit

In case of fiscal deficit, a $10 per barrel increase in crude prices leads to a maximum additional spending of $12.5 billion, assuming no changes in taxes and no-pass through of higher prices to consumers, according to a January 2019 paper by the Reserve Bank of India. This means a fiscal slippage of about 43 basis points as a percentage of the GDP.

However, with the deregulation of petrol and diesel prices, the impact would be lower, the paper admitted, adding that the exact impact is difficult to compute.

According to Saugata Bhattacharya, chief economist at Axis Bank Ltd., the decontrol of petrol and diesel prices means the fiscal deficit is unlikely to see an adverse impact from higher crude prices. In recent quarters, the government has passed on higher crude oil prices for petrol and diesel, while it has retained kerosene and LPG subsidies, Bhattacharya said.

India’s petroleum subsidy bill for 2019-20 was pegged at Rs 37,478 crore, according to budget estimates. Actual spend between April to November 2019 stood at Rs 29,556.6 crore, or 79 percent of the estimated spending. As such, any additional spending on account of a spurt in oil prices is unlikely to hurt the current year’s deficit projections significantly.

Bhattcharya added that higher oil prices may actually benefit states by helping them shore up tax collections. Taxation on petroleum products is on an ad valorem basis, which means that tax revenues rise as prices move up.

The Oil Math: Current Account Deficit

The RBI paper said that a $10 per barrel increase in crude oil prices over a year adds $12.5 billion to India’s current account deficit. Assuming no change in the GDP projections, the current account deficit as a percentage of GDP rises by 43 basis points, the RBI study estimated.

In the current environment, weak domestic demand may prove to be a silver lining.

From April to November 2019, India’s petroleum and crude imports contracted by 12.12 percent as domestic demand contracted. Exports fell by a lesser 10.97 percent, according to data from the Ministry of Commerce and Industry.

The current account deficit is expected to remain narrow and manageable, and both oil- and non-oil deficits will remain in check in 2020, said Rahul Bajoria, chief India economist at Barclays Plc. Even over a longer period, India’s oil deficit as a percentage of the GDP has been moderating, said Bajoria, especially when compared to the gains made in services exports.

The current account deficit for the quarter ended September stood at $6.25 billion as compared to a deficit of $19.03 billion in the same quarter of the previous financial year.

The Inflation Hit

The hit from higher oil prices on inflation, however, may prove to be material at a time when prices across items like food and telecom are already on the rise.

Consumer price inflation and wholesale price inflation see a direct and indirect impact of higher crude oil prices. Fuel and light make up 6.84 percent of the Consumer Price Index, while transport and communication’s weight in the CPI index is 8.59.

The RBI paper found that a $10 increase at $65 per barrel will have a direct impact of 24 basis points and an indirect impact of 26 basis points on retail inflation, adding to a total of around 49-basis-point impact.

Retail inflation is likely to see a more immediate and greater impact of higher crude prices at a time when food prices are anyway increasing, said Madan Sabnavis, chief economist at CARE Ratings. The impact is likely to be seen in inflation figures for January, he said.

For inflation, a sustained $10 rise can mean higher CPI to the tune of 50 basis points, which could complicate RBI’s policy outlook, said Bajoria.