Decreasing Crude Oil Prices- Does it really Benefit India?
Posted in Finance Articles, Total Reads: 1421
, Published on 02 April 2015
With the oil crashing to the new lows, not considering the negative impacts on India might just delay the bursting of the bubble of hope
On 12th Jan 2015, RBI Deputy Governor Urjit Patil while addressing an event said that the dramatic fall in oil prices is a boon for the Indian economy. The drop in the prices of crude oil by almost 60% since June will act in favour for the country by improving the macro-economic factors. India, the world’s fourth largest consumer of oil gets around 70% of its energy needs met by the imports from the oil exporting countries which on the other hand because of the free fall of the prices are spending sleepless nights. In simple economics terms the fall is the result of a mismatch of supply and demand of oil throughout the globe. On the supply side, United States, which was the biggest oil importer has doubled oil production creating a big gap between the supply and consumption of oil.
The OPEC countries are not cutting on the oil production despite a fall in the demand. And on the demand side, the Asian Pacific and Europe part of the globe is suffering from an economic slow-down which is leading to a fall in the demand. The delivery of Brent crude oil in February has fallen down to as low as $45.50 a barrel, lowest since April 2009. The fall will help curb the country’s import bill enabling the oil marketing companies (OMCs) reduce the prices of petrol and diesel helping the consumers enjoy an extra jingling in their pockets. The aviation and automobile sectors are likely to get a boost since the cost of production will fall. This article talks about the various effects the falling oil prices is going to have on India in both the short term and long term and analyse whether the picture is really as rosy as it looks for the Indian economy.
Lower the import bill narrower will be the twin deficit namely the current account deficit (CAD) and the fiscal deficit. With a decrease of every $1 in the oil prices, the import bill gets reduced by Rs 4,000 crore and with a decrease of $ 10 the CAD gets reduced by 0.5% and the fiscal deficit by 0.1% of GDP. For the oil giants like ONGC and Cairn the profitability will be more because the burden of the subsidies given will be less for the companies since the cost of funds will be less for the companies. The entire economy will get a boost since lower crude oil prices helps in the management of the macro-economic factors. It has led to formation of a domino effect in the economy. It led to the stabilization of the inflation which subsequently was responsible for the rate cut done by RBI on 15th January 2015. The rate cut was immediately followed by the lending rate cut done by most of the commercial banks. This move will affect the consumption and investment factors of the economy bringing smiles on the faces of both the consumers and business houses. The rate cut is expected to be followed by a flexible budget formulation by the new government. So overall, the collapse of the prices will be positive for the economy but there’s a flip side of the story too.
In this era, collapse of any economy can be a concern for India. Russia is the second largest exporter of oil in the world having 50% of the state income coming from the oil reserves. With the sanctions by US and EU and the unstable home currency, the international market is losing confidence on Russia. Russia is looking to find out alternative links for trading and other international affairs because of the sanctions. India has emerged as one of the important country to do so. On the same day of the rate cut done by RBI, the Bank of Russia announced that Russia is showing the initial signs of stagflation (An economic situation where the country suffers from high inflation and low growth). But the situation is pretty different for the developed countries.
Most of the developed ones are suffering from deflation accompanied with slow growth. And with the prices falling, the oil importing countries will be having even lower inflation which will slow down the economies and hence will neither be helpful for the Balance of Payment nor for the trade aspect of India. It will impact the exports of India that includes petroleum products which roughly is estimated as one fifth of the total exports. To maintain a favourable balance of payment India is dependent on foreign institutional and foreign domestic investments which will get a hit with the global slowdown. India itself might suffer from deflation. It showed 0% inflation on the Wholesale Price Index (WPI) in November 2014 and gradually went up to 1.77% in October. Recent surveys show that the demand in the sector of manufacturing and capital goods is really low and policies are needed to be framed in an effective and efficient way. There’s a high possibility that with the fall in the crude oil prices the inflation might come down to negative which will act against the growth component. The economy is hoping to see more rate cuts in order to generate demand in the economy.
For India, the down-stream oil companies are gaining because of lower working capital requirements but in the same time the upstream and the refining companies are losing out on the revenues. This is because the cost of inventory and capital has increased for these companies. With every fall of $1 in crude price ONGC’s annual net revenue is trimmed by roughly Rs800 crore and net profit by Rs.450-475 crore. For the refining companies, they have to maintain GRM (gross refining margin) which is basically the difference between the total output of the petroleum refinery i.e the petroleum products and the input i.e the raw material which is the crude oil. This is calculated in terms of per barrel and a falling value of the refining margin means a bad news for the company which is exactly the case with the Indian refining companies. The inward remittances and investment of the sovereign wealth funds are going to get a hit because of the slow-down of the foreign countries.
With an important commodity as the crude oil which is the most tradable commodity in this world, everybody has started speculating and forecasting the prices along with the global inflation rate in the coming few months. JP Morgan has predicted that if the prices remain below $60 this quarter, then the world will see such levels of inflation which has not been seen since the US Recession 2008-09. Bank of America has said the prices might fall as low as $31 per barrel by the end of this quarter. It is predicted that the oversupply will ease by the end of 2015. Even if the demand resumes and the supply is reduced the prices will not cross $100 per barrel overnight since it’s going to take a while for the supply and demand to be at equilibrium.
India surely is gaining from the price fall, but if it stays for a long period of time then the positive effects can be over-weighted by the impact of slow global growth. In the long run neither the oil producing countries will survive nor can the other economies survive because all the nations are directly or indirectly independent on each other.
This article has been authored by Pushpanjali Mitra from Symbiosis Institute of Management Studies