Crude oil deficit to high inflation: How can the Israel-Hamas war impact Indian economy? — Explained
- Israel-Hamas War Impact: India may see a higher import bill, wider current account deficit and inflationary pressures, if the international crude oil prices remain elevated for a longer period over the ongoing global geopolitical tensions.
The current geopolitical conflict in the Middle East due to the ongoing war between Israel and Palestinian terrorist group Hamas has brought fresh global headwinds for the Indian economy. Ever since the war broke out earlier this month, international crude oil prices have risen over 5 per cent and US bond yields have breached the 5 per cent-mark to hit 16-year high levels.
The economic impact of global oil supply have important implications for India – a net importer of crude oil – to deliver price stability. Analysts say that India continues to see macroeconomic stability at this moment, but is vulnerable to one key risk - supply disruption in crude oil prices because of escalation in the war, resulting in a spike in crude oil prices.
International crude oil prices may rise significantly if Iran - which is a major supporter of Hamas, joins the war. If that happens, it may lead to selling pressure in the market. To explore the domestic implications better, let's first understand how the Israel-Hamas war can impact the global economy:
Also Read: From high inflation to import bill - the domino effect of rising crude oil prices on Indian economy
How can the Israel-Hamas war impact the global economy?
With major oil producers Saudi Arabia and Russia announcing oil supply cuts of a combined 1.3 million barrels per day (mbpd) till the end of the year, the global economy already faces an oil market deficit.
Now, with oil prices hovering above the $90 per barrel-mark, the escalation of the conflict towards other Middle Eastern oil producers is concerning and requires careful monitoring, especially given the global economy's 'higher for longer' interest rate scenario.
The oil supply is unlikely to be threatened unless the issue expands to other nations in the region and becomes a proxy conflict between the US and Iran.
‘’Brent had crossed the $90 mark but then retreated. Now, we can use the $90 number to be the threshold beyond which there is trouble for the world economy,'' said Shantanu Bhargava, Managing Director, Head of Discretionary Investment Services, Waterfield Advisors.
When oil prices rise, the cost of production for various industries and energy costs for businesses and households also surge, driving global inflation higher. High energy prices and new inflationary trends could undermine the efforts of central banks to bring inflation under control.
With this, central banks across the globe will continue hiking interest rates, which will slow down the global economic growth.
The global economy faces high inflation again as crude oil prices rise. If oil prices stay high, the US, India, China, and other major nations that import oil may see substantial import inflation. Let's take a look at how the war can impact the Indian economy:
How can the Israel-Hamas war impact the Indian economy?
High import bill, wider current account deficit:
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. It can result in a trade deficit, as India has to spend more on oil imports, which can, in turn, put pressure on the country's current account balance.
‘’High crude oil prices hurt India impacting currency stability, possibly worsening the government’s fiscal deficit (the government is likely to absorb higher prices by cutting excise duty), widening the current account deficit (CAD) further impacting currency adversely and affecting the profit margins of sectors such as aviation, paints, tyres and chemicals,'' said Waterfields' Shantanu Bhargava.
CAD is a key indicator of the balance of payment of a country and in the current scenario of the momentum picked up by crude rates, every $10 dollar rise in Brent futures potentially widens the CAD by 0.5 per cent, according to market experts.
‘’Every 10 dollar rise in Brent crude prices widens India’s current account deficit by 0.5 per cent. Consequently this depreciates the INR and leads to imported inflation,'' said Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.
Weaker Indian Rupee
High oil prices pushes the US dollar above against its peers, which in turn, is a downside for the Indian rupee. Since India pays for oil imports in dollars, a higher oil import bill can lead to an increase in demand for dollars, potentially weakening the rupee against the dollar.
Refining Margins of OMCs:
If the crude oil price continues to rise, it could have a significant impact on some specific stocks and the broader economy. The Indian crude oil basket has averaged ~ $80.1 per barrel in the first five months of FY24. But the price of the Indian crude basket touched $90.7 per barrel in the first week of September.
If Brent crude prices remain elevated for the remainder of the fiscal year, we anticipate that the full-year average price for Indian crude oil basket could be ~$86-87 per barrel, according to estimates given by brokerages.
High international oil prices will raise the average Indian crude basket price and the oil marketing companies (OMCs) including Indian Oil, Bharat Petroleum Corp Ltd (BPCL) and Hindustan Petroleum Corp Ltd (HPCL), will register losses in gross refinery margins.
‘’As we approach the pre-election period, we anticipate that OMCs will absorb a significant portion of the elevated global crude prices. The government may also consider partially sharing this burden with OMCs by reducing certain duties and taxes on retail fuel prices,'' said CareEdge Ratings.
Also Read: Indian crude basket to average $87/bbl, OMCs to bear the brunt as oil surges 6% over Israel-Hamas war
Inflation:
An increase in international oil prices may lead to higher fuel prices, which can trigger inflationary pressures. According to the Reserve Bank of India (RBI), 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.
High fiscal deficit:
The government often subsidizes fuel prices to protect consumers from the full impact of rising oil prices. ‘’If the crude oil prices remain at their elevated level for longer, the government may need to increase subsidies or absorb a portion of the price increase, leading to a higher fiscal deficit'', according to ICICI Securities.
In simple words, 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).
Catch all the Business News , Economy news , Breaking News Events andLatest News Updates on Live Mint. Download TheMint News App to get Daily Market Updates.
Business NewsEconomyCrude oil deficit to high inflation: How can the Israel-Hamas war impact Indian economy? — Explained
First Published:24 Oct 2023, 06:06 AM IST
- Top Gainers
- Top Losers
- 52 Week High