A surge in crude oil prices threatens to stoke inflation, derail earnings growth of companies, and hurt India’s economy in the year ahead.
As the world’s third largest importer of oil, India is among the most vulnerable to rising energy costs. It imports more than 80% of its oil requirements. With Brent crude at a six-month high, it poses a clear risk to India’s fiscal health. Inflationary pressures may also prompt the Reserve Bank of India (RBI) to rethink the pace of interest cuts.
Last week, Brent crude oil rose above $75 per barrel for the first time in 2019 in the wake of tighter sanctions on Iran. The US said it would end all exemptions for sanctions against Iran, demanding countries halt oil imports from Tehran from May or face punitive action from Washington.
So far this year, crude has jumped nearly 33%, while Sensex is up over 8%. In April so far, Brent has climbed 5.25%.
Christopher Wood, managing director and equity strategist at CLSA, in his weekly note to investors, Greed & Fear, said oil price is just as likely to spike to a “three figure" level if the US really implements the threatened policy, just as was also the case six months ago. He thinks that higher oil prices are probably the biggest risk for the Indian equity story on a five-year view.
“In an Asian or, even better, emerging market portfolio, that risk is best hedged by owning oil stocks. In this respect, any decision by (US President Donald) Trump to back off (from) his aggressive stance on Iran should be viewed as an opportunity to add to oil play," Wood said in his note published last week.
As a base case, he expects the US may soften its stance on crude oil.
UK-based Oxford Economics expects Brent rising to $100 per barrel by the end of 2019. “When this happens, global GDP (gross domestic product) growth may decline by 0.6% in 2020 with global inflation rising by 0.7 percentage point," it said. It added that the hardest hit economies in 2020 are large oil-importing emerging markets such as the Philippines, China, India and Argentina.
While there is a possibility that the impending supply crunch would be alleviated by higher production elsewhere, a single supply shock could easily send oil prices to shoot up to $100 per barrel, Oxford Economics said.
Brent crude had touched $100.6 per barrel on 9 September 2014 and is currently down 29% from that level.
“The risk from a supply-side driven rise in oil prices is negative for Asia markets and especially for India, the Philippines and Thailand," said Nomura in a note on 24 April. It had said that the economies that could suffer the most due to rise in oil prices are Cambodia, Romania, Turkey, Sri Lanka, Ukraine, India, and Pakistan.
According to Nomura, economic impact due to high crude price is felt much more in emerging markets (EM) than developed markets, and within EM economies, there are likely to be clear-cut winners and losers. “This is because of the risk of non-linear economic effects, or vicious spirals, to large net oil importers that have weak economic fundamental starting positions. The prospect of even larger twin current account and fiscal deficits could trigger sizeable net capital outflows and currency depreciation which, in turn, may add further upward pressure to inflation," Nomura said.
According to Kotak Institutional Equities Research, the Indian market seems to be suddenly worried about the deterioration in India’s macroeconomic conditions, especially with global crude prices reaching “danger" levels from India’s current account deficit (CAD) and balance of payment perspective and rich valuations of the market, which offers little room for any earnings or political disappointments. “Any further increase in crude oil prices to over $75 per barrel will put further pressure on India’s macroeconomic position. A $10 per barrel increase in oil prices impacts India’s CAD by around $15 billion (50 basis points of GDP)," it said in a report on 23 April.
Economists at Nomura estimate that every $10 per barrel rise expands the CAD by 0.4% of GDP.
CARE Ratings said with a permanent increase in crude oil prices by 10% under ceteris paribus conditions could translate into the CAD increasing by 0.4-0.5% of GDP. It said rupee will be under pressure and dollar outflows will be the natural outcome of higher oil prices.
“Sustained increase in the price in the range of $70-75 per barrel or higher can move the rupee down by 3-4% on an annual basis given that the dollar has already started strengthening in the world markets," it said in a report on 23 April.
CARE Ratings also added that rise in crude prices may lead RBI to postpone a rate cut in the June bimonthly committee meeting.
Analysts said rising crude prices may hurt the margins of Indian companies amid growing expectations of an earnings revival, which is very critical to sustain Indian markets rally in this year as the country is electing its new government in May.
Vinod Karki, vice-president (strategy) at ICICI Securities Ltd said besides impacting the broader macroeconomy, rising crude prices also impact micros in terms of corporate earnings as demand is impacted.
“Rise in crude prices also impact raw material supply chain of many manufacturing companies as India imports a major portion of its crude requirements. Impact on demand and higher input costs puts pressure on the operating margins and it has to be seen if this extent of price rise will be absorbed or passed on to consumers. Indirectly, there will be additional burden of freight cost for some companies. However, the negative impacts will materialize only if oil continues to sustain at elevated levels," he said.
Bloomberg contributed to this story.