New Delhi/Mumbai: A flare-up in global oil prices and worries about its negative impact on the Indian economy rattled the equity market days before finance minister Pranab Mukherjee presents the budget on Monday.

The benchmark Sensex fell 546 points on Thursday, or 3%, to close at 17,632 the steepest fall in nine months. Disruption in oil supplies as Libya tumbled into chaos sent the price of a barrel of Brent crude to as much as $119, the highest in 30 months.

Ahmed Raza Khan/Mint

While the expiry of near-month derivative contracts on Thursday contributed to the volatility in the markets, it was primarily the rise in crude prices that spooked investors, said Kaushik Dani, head of equities at Peerless Funds Management Co. Ltd, that has assets worth Rs2,036 crore. The sharp rise in oil prices will likely add to economic stress in India, which is already battling high inflation.

India is vulnerable to an oil shock because of the high current account and fiscal deficits, a report by Citigroup Global Markets Inc. said on Thursday. “India’s current account deficit is among the widest while the net oil trade deficit is relatively large," the report said. It also pointed out that “fiscal risks from subsidies (are) likely the highest" in India and Pakistan among Asian countries.

Mukherjee is expected to announce on Monday that the fiscal deficit will be within the limits set last year and that India would continue to shrink its budgetary gap in the next fiscal as well. However, more expensive oil will put the government in a spot: it will either have to pass on the extra costs to consumers and fan further inflation or pick up the bill by increasing subsidies, which will in turn push up the deficit.

Citigroup also said a $1 per barrel rise in global oil prices will widen India’s trade deficit by $700 million, or 0.04% of gross domestic product (GDP).

A senior government official said that while higher oil prices would increase the trade deficit, there was no need as yet to assume that oil prices would stay at these elevated levels for long.

“India’s annual oil import bill could rise 25-30% if crude oil remains (at) $100-120 per barrel," commerce secretary Rahul Khullar said. “In the remaining two months of the fiscal year (February and March), we may have to make excess payment of $3-4 billion on oil imports. Next year, we have to pay a much higher bill if we do not do something."

However, he warned against getting carried away by the “temporary disruption in oil supply". “Who says the price will stay at this level? The oil shock is due to current developments in the Arab countries. Do not get carried away by this," he said.

Samiran Chakraborty, head of research at Standard Chartered Bank said oil at $120 a barrel is a risk from the inflation, current account deficit and fiscal perspective. “We need more time and information to see if the oil price spike is permanent or temporary in nature. Speculators could also be taking advantage of the situation," he said.

Chakraborty said it was unlikely the issue would be addressed in the budget. “By now, the budget document must be ready," he said.

India imports 80% of its crude needs, accounting for 3.5% of global consumption. The country consumes 144 million tonnes (mt) of oil a year, with domestic production accounting for 34 mt. India’s oil imports during the first nine months (April-December) in the current fiscal stood at $72,554 million, rising 17.7% over the same period a year ago.

India imported around 9,47,000 tonnes of crude oil from Libya in 2009-10 and plans to import nearly 1.1 mt in the current fiscal. “India can’t support these prices. Some amount of speculation is built into it. There is no shortage of crude today, but the spiralling prices are a result of anticipated prices," said S.V. Narasimhan, chairman, Indian Oil Corp. Ltd.

Ajit Ranade, chief economist, Aditya Birla Group, said there was limited scope for the government to make an across the board increase in fuel prices under the present circumstances. “The government has to look at other creative ways to address the situation like excise relief, quantitative limit on subsidies and focus on non-fossil energy."

Ranade said that any spike in crude prices will be a challenge to the Indian economy because of the high oil dependence of the country. “We need to have strategic oil reserves like the US or China. We also need to increase our strategic ownership of oil assets abroad," he added.

A sharp rise in crude prices has led to a pull-back in the global equities market. Most major markets have declined in the past couple of trading sessions. While the Sensex saw a decline of 4.7% over the past week, indices in the developed market such as the FTSE 100 and S&P 500, fell by over 2% in the same period. Russia, which is typically considered a commodity play, was the only gainer among the Bric (Brazil, Russia, India, China) nations with its benchmark index, Micex, rising 0.7% over the past week.

Stocks fell across sectors with oil-dependent and interest-rate sensitive sectors among the hardest hit. Consumer durables, banking, real estate and automobile stocks were the biggest losers on Thursday, falling by more than 3%. So were aviation stocks such as Jet Airways (India) Ltd, Kingfisher Airlines Ltd and SpiceJet Ltd, all falling more than 5%.

“I would expect the markets to fall another 3-4% near term," said Vivek Mahajan, head of research, Aditya Birla Money Ltd.

Unless crude oil prices stabilize, it is unlikely foreign investors will invest in India, analysts said, limiting the chances of the market moving up. Foreign investors have so far sold a net $1.59 billion in equities this year, after pumping in a record amount last year.

Utpal Bhaskar in New Delhi, Aveek Datta in Mumbai and Bloomberg contributed to this story.