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Business News/ Opinion / The oil price kicker for India
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The oil price kicker for India

Lower prices gives a kicker at a time when slow process of repairing macro fundamentals is underway

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

Oil prices hit a 13-month low earlier this week and by all indications, the risk of prices spiralling higher, despite geopolitical tensions, is low.

Over the past 12 months, Brent crude prices are down 6% while WTI (West Texas Intermediate) prices are down nearly 9%. The past six weeks alone have seen a near $10 fall in prices, which are now far below the all-time highs of July 2008 when Brent and WTI were both trading above $145 per barrel.

This fall in oil prices is especially noteworthy because prices are continuing to correct despite news of an escalating conflict in Iraq, civil war in Syria and chaos in Libya. Individually and collectively, all this news should have been bullish for oil. Instead prices have continued to correct.

“Oil prices seem almost eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world," noted the International Energy Agency in its report on Tuesday.

As is now well documented, the increased supply of oil is one reason why this market is no longer attracting the kind of speculative and trading interest that it has in the past, which has also been partially responsible for previous oil price spikes. Global oil supplies have risen by 840,000 barrels per day between July 2013 and August 2014, with crude oil production in the US at its highest levels since 1987. As supply is increasing, demand is muted. A slowdown in Europe, China and some parts of the emerging world has meant that the demand for oil has been kept in check.

Neither of the above mentioned factors is likely to change in a hurry and, hence, the outlook for global oil prices is relatively benign. If anything, the downside risk to prices seems to be more pronounced.

The scenario of lower or even steady oil prices provides a useful kicker to India at a time when the slow process of repairing macroeconomic fundamentals is underway. Lower prices will help keep the fiscal mathematics at the centre, provide the government with the perfect opportunity to unwind oil subsidies without stinging the system, and also help in the inflation fight to an extent.

Let’s start with the the fisc. The budget has pencilled in oil subsidies of 63,427 crore, compared to last year’s actual subsidy of 85,480 crore. In the first quarter of the current fiscal, under-recoveries on diesel, kerosene and LPG stood at 28,691 crore. If you annualize this, you get under-recoveries of roughly 1,14,764 crore for the year. Last year, upstream companies such as Oil and Natural Gas Corp. Ltd, GAIL India Ltd and Oil India Ltd shared 48% of the subsidy burden, while the government took care of the rest. Assuming no change in that equation, the government’s share of under-recoveries currently stands at roughly 55,086 crore.

What this implies is that the government may be in a position to cap oil subsidies below the current budget estimate. That’s great news for the government, which is struggling to stick to a 4.1% fiscal deficit target for the current year.

The situation could improve further if diesel prices continue to be adjusted higher via monthly price adjustments of 50 paise per month. Current under-recoveries on diesel stand at near 1.30 per litre, which means that diesel subsidies should be eliminated by the end of the calendar year. But the government may have already built this into its budget projections. Even so, lower global prices will allow the country to move towards market-linked diesel prices quicker and in a less painful way.

On the external account, too, the need to pay fewer dollars for barrels of oil will be helpful, especially if pressure on the Indian currency re-emerges. India imports about 80% of its oil and the oil import bill last year was $142 billion, according to data from the Petroleum Planning and Analysis cell. With prices coming off, this should reduce and the demand for dollars from oil companies will be kept in check. Sure, currently the market is well supplied with dollars but should a situation arise where we once again start to see foreign outflows (the central bank governor recently warned that India could be challenged by outflows if rates in the US rise), lower demand for dollars from oil companies will help ease the pressure on the market.

Then, of course, there is inflation. According to data from Yes Bank Ltd, the reduction in petrol prices of 1.89-2.38 per litre announced this week will have a direct impact of roughly 3 basis points on the wholesale price index. One basis point is one-hundredth of a percentage point. The impact on the consumer price index is tough to judge as fuel gets subsumed into the transportation index. So, the immediate impact of lower global oil prices on inflation is negligible.

But consider the counterfactual. At a time when the Reserve Bank of India has set itself a stiff target of bringing down consumer inflation to 6% by 2016, higher oil prices could have played a spoiler.

Net net, the lower global oil prices are probably a case of sweet serendipity that policy makers in India should be thankful for!

Ira Dugal is assistant managing editor, Mint.

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Published: 14 Aug 2014, 05:30 PM IST
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