From high inflation to import bill - the domino effect of rising crude oil prices on Indian economy

Saudi Arabia and Russia extended their voluntary oil output cuts to the end of the year which resulted in a sharp surge in crude oil prices, with benchmarks Brent and US West Texas Intermediate (WTI) crude futures scoring 10-month high peak levels. 

While Saudi Arabia has cut oil supply to the tune of 1 million barrels per day (bpd), Russia has restricted the output by 300,000 bpd. These are on top of the April cut agreed by the Organisation of Petroleum Exporting Countries and its allies (OPEC+) running to the end of 2024. 

After the announcements, Brent crude futures rose by $1.04, or 1.2 per cent, to settle at $90.04 a barrel on Tuesday, closing above the $90 mark for the first time since November 16, 2022. US WTI futures had gained $1.14, or 1.3 per cent, to settle at $86.69 a barrel, also a 10-month high.

Investors had expected Saudi Arabia and Russia to extend voluntary cuts into October, but the three-month extension was unexpected. Today, OPEC nations produce around 30 per cent of the world's crude oil. Saudi Arabia is the largest oil producer within the cartel, producing more than 10 million barrels a day. 

OPEC+ pumps around 40 per cent of the world's crude and its policy decisions can have a major impact on oil prices. High global oil prices could impact emerging economies such as India - a country largely dependent on imports to fulfill its energy needs.

Also Read: Higher CPI, volatile stocks and yields: RBI explains how OPEC decisions impact Indian economy

How will high crude oil prices impact the Indian economy?

The economic impact of global oil supply have important implications for India – a net importer of crude oil – to deliver price stability. Moreover, the oil supply-related news shocks cause a sustained increase in consumer prices and reduce the domestic output - for a short duration. 
 

1.High import bill

India - a net importer of crude oil which fulfills as much as 85 per cent of its energy needs through imports, may see a heavier import bill if international crude oil prices keep rising throughout the year. India produced a total of 2.50 million metric tonnes (MMT) of crude oil in July 2023 - registering a growth of 2.1 per cent compared to the year-ago period, according to Petroleum Planning & Analysis Cell (PPAC).

Crude oil imports decreased by 6.3 per cent and 2.4 per cent during June 2023 and April-July 2023 respectively, compared to the corresponding period of the previous year. The net import bill for oil and gas was $9.8 billion in July 2023 compared to $15.8 billion in July 2022, according to PPAC.

2. High petrol, diesel prices

Oil marketing companies (OMCs) including Indian Oil, Bharat Petroleum Corp Ltd (BPCL) and Hindustan Petroleum Corp Ltd (HPCL) may be forced to lift the freeze on petrol and diesel prices on rising international crude prices. 

OMCs did not significantly increase the retail prices last year even after crude reached a peak of $140 per barrel in March 2022. Due to this, the oil refiners registered losses as petrol and diesel rates have been unchanged since April 2022.

However the central government can force OMCs to cut petrol and diesel prices as their balance sheets have largely got repaired due to stronger profits in the current fiscal. Domestic brokerage firm JM Financials expects the government to cut petrol and diesel prices around Diwali as state elections begin in November-December 2023.

“OPEC+ is ramping up petrol price pain, triggering fresh and increasing concerns about rising global inflation - which was just beginning to ease - meaning central banks could possibly push higher-for-longer interest rates,'' said Nigel Green, CEO, deVere Group, UAE.

“Restricted oil supply leads to higher oil prices, which, in turn, can contribute to higher fuel prices for consumers and businesses, putting upward pressure on the overall inflation,'' added Green.

3.Depreciation of Indian Currency

High oil prices pushes the US dollar above against its peers, which in turn, is a downside for the Indian rupee. A stronger dollar can weigh on oil demand by making the fuel more expensive for holders of other currencies.

The Indian rupee depreciated 14 paise to hit a 10-month low level against the US dollar on Wednesday tracking losses in Asian peers and a sharp surge in crude oil prices. The Indian currency fell to 83.18 to the US dollar as against its previous close of 83.04. Rupee opened at 82.02 a dollar.

"The rupee faced weakness, declining by ₹0.07 to 83.13, primarily due to a rally in the dollar index, which surged above 104.50$. Additionally, the sustained rally in WTI crude oil prices, holding above 85$, contributed to the rupee's decline,'' said Jateen Trivedi, VP Research Analyst at LKP Securities.

In recent sessions, the rupee's weakness seems to be factoring in the possibility of another rate hike by the US Federal Reserve. While recent economic data in US has been supportive of the Fed keeping rates unchanged, analysts reckon that the persistent pressure from inflation may push the Fed and other central banks towards considering further rate hikes.

‘’As a result of these factors, the rupee's trading range has shifted lower and can now be expected to fall within the 82.90-83.30 range,'' added Trivedi.

4.High fiscal deficit

Higher crude oil prices will increase the subsidy burden for the central government. The government bears the difference between the market price and the controlled price of oil and gas end-products such as kerosene, diesel, liquified petroleum gas (LPG). This is likely to widen the fiscal deficit - expressed as a percentage of the country's gross domestic product (GDP).

As per recent official data, the government's fiscal deficit, or the gap between spending and receipts met through borrowings, crossed ₹6 trillion, or a third of the ₹17.9 trillion estimated in the union budget for FY24.

Currently, the fiscal deficit stands at 33.9 per cent of the full year target, aided by strong tax and non-tax revenue receipts. Overall revenue receipts in the first four months of this fiscal stood at ₹7.6 trillion or 29 per cent of the full year target.

5.India's balance of trade

Rising crude oil prices will increase India's dependence on foreign exchange reserves and external borrowing in order to finance its oil imports. This is likely to expose the Indian economy to currency fluctuations and financial shocks that arise from the impact of high crude prices.

A stronger US dollar and rising US bond yields makes the Indian currency weaker, which impacts the trade deals in commodity baskets. The weaker currency suffers losses in such deals as foreign investors pull away their money during price shocks. Higher crude oil prices will also affect the country's trade balance and terms of trade with other countries.

6.Inflationnary Pressures

The oil supply cuts could worsen the current account deficit by around 0.4 per cent of the GDP. The high retail prices of petrol and diesel would further lead to rise in the price of domestic commodities as well.

The sustained increase in prices is expected to lead to a lower aggregate demand as households and firms are left with less disposable incomes to spend on non-energy goods. This is how domestic consumer prices respond to an oil supply news shock.

Surprise changes in oil prices can also influence the price and wage-setting in the economy by altering the inflation expectations of firms and households, and so, domestic economic activity falls on impact of such a shock. However, the impact is felt only for a short duration as it reverts to mean quickly, according to the Reserve Bank of India (RBI).

7.Lower Economic Growth

Higher crude oil prices will increase the cost of production and transportation for various sectors, affecting their profitability and competitiveness. This will reduce the disposable income of consumers, affecting their demand for goods and services. 

Analysts say that consumer behaviour plays a critical role because when fuel prices rise, consumers may cut back on discretionary spending, which can impact economic activity. Reduced consumer spending influences the inflation dynamics, especially in sectors heavily dependent on consumer demand.

India is the fourth-largest global energy consumer behind China, the United States and the European Union.

Higher inflation and lower economic activity will impact the monetary policy. ‘’As rising oil prices are expected to have a sustained impact on inflation, central banks can be expected to maintain higher interest rates for longer to control soaring prices,'' said Nigel Green of deVere Group, UAE.

“The decision by the group of oil producing countries will further exacerbate the cost-of-living and cost-of-business crisis as inflation is given another global boost,'' he concluded.