The International Monetary Fund, in its World Economic Outlook Update released in January, forecasts India’s growth to increase from 7.3% in 2018-19 to 7.5% in 2019-20. (Reuters)
The International Monetary Fund, in its World Economic Outlook Update released in January, forecasts India’s growth to increase from 7.3% in 2018-19 to 7.5% in 2019-20. (Reuters)

Why oil remains central to India’s twin deficits

  • Given that fuel forms a large share of our imports, the Indian economy remains vulnerable to a crude oil price shock that could feed into inflation
  • If oil prices remain low, the Indian economy could sail along without any major disturbance, and even attract capital inflows

The Union Budget 2019-20 has expectedly shown a slip in the fiscal deficit, at an estimated 3.4% for the current, as well as the next fiscal year. The breach in the reported deficit numbers has, however, been lower than what many had feared, partly owing to optimistic revenue assumptions.

Apart from optimistic tax growth assumptions, one big reason why the fiscal deficit numbers look relatively benign is low oil prices. However, things could change in the event of an oil price shock, a Mint analysis shows.

Only a few months ago a sharp rally in crude oil prices had led to renewed concerns about India’s twin deficits (fiscal and current account), leading to a massive sell-off and fall in the value of the rupee.

As in 2018, oil will, therefore, be central to the fortunes of the Indian economy.

If oil prices remain low, the Indian economy could sail along without any major disturbance, and even attract capital inflows as its growth, despite a slowdown, would still be higher than most other major economies.

The global economy is poised to slow down in 2019-20 due to escalating trade tensions. However, India is expected to buck the trend and actually report an accelerated growth in the forthcoming year. The International Monetary Fund, in its World Economic Outlook Update released in January, forecasts India’s growth to increase from 7.3% in 2018-19 to 7.5% in 2019-20.

But these optimistic growth projections are based on the assumption that oil prices will remain around the $60 per barrel mark in 2019 and 2020.

However, with the extreme volatility in oil prices over the past year, there is reason to be circumspect.

Considering the geopolitical risks surrounding major oil producing countries such as Iran, Qatar and Venezuela, and the threat of Opec (Organization of the Petroleum Exporting Countries) production cuts, stable crude prices are never a foregone conclusion.

The International Monetary Fund’s oil price forecasts in the past have been way off the mark.

If oil rallies, this could spell big trouble for us. In the extreme event of oil prices reaching to $90/bbl, India’s twin deficits will balloon uncomfortably. The current account deficit would rise to 3.5% of the gross domestic product (GDP), the highest since 2012-13.

Assuming that the government absorbs a part of the oil price increase through excise duty cuts, the impact on the fisc would also be significant, and could rise to as high a level as 4%, the highest since 2014-15.

Between 2014 and 2017, the fall in oil prices enabled the government to steadily increase the level of excise duties without causing the prices to rise. It is this windfall that largely helped the government bring down the fiscal deficit.


Lower crude prices have enabled the government to charge higher excise duties on petrol and diesel. However, the gains from the excise duties have plateaued as the government has been compelled to roll back the rate of excise in the face of rising crude prices. In the event of a crude price shock, such roll backs could be larger in magnitude.

Given that fuel imports constitute a larger share of India’s imports compared with other large emerging markets, India is especially vulnerable to an oil price hike, which, apart from raising the twin deficits, would also feed into inflation.


Research by Saurabh Ghosh and Shekhar Tomar of the Reserve Bank of India suggests that India will continue to remain vulnerable to such shocks due to its high import dependence.

“This vulnerability can lead to episodes of sharp increase in the current account deficit and rising GDP growth would be insufficient to counter it," wrote the duo in a recent working paper.

“On the domestic front, such episodes will lead to surge in inflation or fiscal deficit, or both, depending on how much of the increased prices the fiscal authority decides to pass-through."

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