As global oil prices move higher owing to geo-political uncertainties in the Middle East and the rupee continues to weaken, the Indian economy faces gloomy prospects. The impact of the weaker INR and higher oil prices will, on the whole, have negative implications for India’s fiscal balance and inflation. Crude oil price in INR terms is currently at an all-time. Brent crude is getting closer to INR 8,000/barrel and is about 40% costlier than at the end of May, 2013. Accordingly, fiscal concerns are coming back. Under-recoveries have once again gone up in recent months despite continued, albeit small, upward revisions in domestic oil prices. Diesel under-recoveries will likely go up to INR 12/litre by end-August from a low of INR 3.8/litre about three months back. The crisis in the Middle East, initiated by sanctions on Iran and escalated by a war like situation in Syria, is creating uncertainty in global crude supplies. As a result, crude oil prices are likely to rise above the benchmark $120. With India already challenged by the effort to substitute Iranian crude post the embargo, this development is likely to compound India’s energy woes.
The increasing likelihood of some form of US led military action in Syria is compounding concerns about the stability of the world’s key oil-producing region and this is likely to exert upward pressure on prices until the nature of the possible military intervention becomes apparent. But the bigger risk for the oil market is the potential for the Syrian conflict to spread to neighboring producing countries and endanger regional output. Iraq, currently OPEC’s second largest producer, has already seen its security situation significantly deteriorate because of Syria. Violence is running at the highest level in five years because of a renewed round of bombings and shootings. Sanctions on Iran and the recent labor and payment problems in Libya have brought OPEC disruptions to almost 2 million barrels per day (mbd), adding to the 0.8 mbd in unplanned shortages in non-OPEC countries. While Libyan output is trickling through, and improvements could be expected in Iraq with the start-up of new fields; the return of supplies is likely to be staggered with a high possibility of a relapse to low levels in Libya, Nigeria, Iraq and South Sudan. Thus, with geopolitical tension and physical shortages on the rise, crude oil production may be at an inflection point.
Since crude is the biggest component of India’s import bill, a weak rupee is bad for the economy. Oil companies, which pay for crude in dollars, will have to shell our more rupees for importing oil. This will increase India’s current account deficit. The weakening of the rupee means that there is little likelihood of a respite from high fuel prices. The consolation lies with the fact that since global commodity prices have been falling, there is no imminent threat of a price hike in commodities either. However, given the sensitivity of India’s current account to higher oil prices, if oil averages were to remain around US$120/barrel through rest of the fiscal year, it can potentially pose a 30 basis points hike in India’s current account deficit. Softer domestic demand reflecting weak growth momentum and government initiatives to contain the current account gap also remain important considerations in this context.
With an appreciation of the rupee unlikely in the short to medium term, India’s crude import, accounting for over 75% of India’s overall import bill, is likely to increase India’s already stretched Current Account Deficit. In addition, prevailing uncertainties in the Middle East, especially Syria, are likely to push the international crude prices over $120 in the near term. This will compound India’s deficit woes. With India already struggling to substitute Iranian crude, a further drop in supplies from existing sources may severely expand India’s energy deficit. This is bound to have a cascading effect on Indian industry with utilities and infrastructure impacted first, followed by other sectors. These considerations, in addition to the incumbent government’s election largess in the form of the Food Security Bill, are likely to prompt credit agencies to re-evaluate India’s sovereign credit rating, which may have an adverse impact on institutional inflows and credit availability. It’s clear that India’s currency and energy security concerns need to be mitigated, by prompt policy corrections, and by the development of alternate supply markets to source India’s energy requirements.
Debabrata Ghosh is a PGP1 student at IIM Ahmedabad and a member of the Consult Club. He is a graduate from BITS Pilani in Chemical Engineering.