Oil Above $100: What It Means For The Indian Economy

Brent crude oil prices have continued to soar, rising to $110 per barrel as Russia continued military operations in Ukraine. Oil prices are trading in triple digits for the first time since September 2014.

Over this seven-and-a-half-year period, India's macroeconomic conditions have changed. The high level of forex reserves and some buffer in the form of higher excise duties on fuel products suggest that India has room to cushion the impact of higher crude oil prices. Still, certain indicators, such as the current account deficit and inflation, bear watching.

The rise in oil prices amid conflict between Russia and Ukraine can be viewed as a "multitudinous risk" for India, said Yuvika singhal, economist at QuantEco Research. It can push inflation and inflation expectations higher, widen the CAD and weigh on the rupee and growth recovery, she said.

Current Account Deficit

India is a large importer of crude oil. As such, the first point of impact of higher crude oil prices is the current account. The rising crude prices are coming at a time when the current account deficit has already widened.

In the September-December 2014 quarter, India's current account deficit stood at $8.2 billion or 1.6% of GDP. In contrast, India's current account deficit in the quarter ended September 2021 was at 1.3% of GDP or $9.6 billion.

In a hypothetical scenario, where oil prices spike to $150 per barrel for two months due to geopolitical tensions, the current account deficit would widen by $11 billion or 0.3% of GDP, said CLSA economist Indranil Sengupta in a note this week.

Others see a larger hit. Suvodeep Rakshit, senior economist at Kotak Institutional Equities said that the current account deficit could widen to 3% of GDP in FY23, from 1.8% in FY22, assuming crude averages around $100 per barrel in FY23.

This would imply a large drawdown on foreign exchange reserves if we pencil in relatively muted equity and debt flows, he said, adding that this will put pressure on the rupee.

Forex Reserves

India has far greater protection against any volatility in its balance of payments.

Forex reserves, at present, are at $630 billion. In September 2014, when oil prices were at these levels, reserves were at $316 billion.

Even in terms of imports, the cover provided by forex reserves is at over 10 months of total imports using the last available data. In September 2014, the import cover was just over seven months.

"We estimate the RBI's adequate forex reserves at $600 billion against the current $680 billion (including forwards). Our assumptions of higher oil prices and FPI outflows (estimated at $20 billion) imply a drawdown of $30 billion," said Sengupta. "This will still leave the RBI with a large $50-billion war chest to fend off any speculative attack."

Inflation

Higher oil prices will also hit inflation, depending on the extent of the pass-through.

Retail inflation is currently just above 6%. In September 2014, retail inflation was at 6.46%, having dropped from 7.73% in the previous month.

The RBI's estimates, based on the study cited earlier, suggest a $10 per barrel increase in crude oil prices could have a direct impact of 24 basis points and an indirect impact of 26 basis points. This was when only the transport component of CPI was used to measure the direct impact and where the pass-through to pump prices was only 66%.

Every $10 per barrel increase in the India crude basket, has a direct impact of about 20 basis points and a more staggered impact of an equal magnitude as a second order effect, as per estimates from QuantEco Research.

"Despite the run up in crude oil prices so far in 2022, retail fuel costs have not been adjusted upwards by oil companies in January and February 2022, ahead of the impending state elections," Singhal said. "Lagged adjustments are expected to begin in March this year, post elections, adding to pipeline inflation pressures."

There is, however, some buffer available here as the government can choose to lower excise duties on fuel products to blunt the impact of higher global oil prices on consumers.

A reduction of Rs 5 in excise duty on petrol and diesel can soften inflation by about 8-10 basis points directly and by an equivalent amount of indirect or second order impact, according to estimates by Singhal.

Growth

Should higher oil prices impact inflation and lower disposable spending, growth could see an impact as well.

GDP growth in the July-September quarter of the current fiscal was at 8.4%. However, growth rates in recent quarters have been distorted by base effects due to the pandemic. In the October-December quarter of FY15, when oil prices were last at these levels, GDP growth was at 5.9%.

From growth perspective, a rally of $10 per barrel in the India crude basket, could shave off 10 basis points from the annual GDP growth estimate, Singhal said.