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Photo: Bloomberg
Photo: Bloomberg

Opinion | The prospect of an oil stimulus in the time of Covid-19

A supply glut along with falling demand could prove to be a mixed blessing for India

Three major players in a market are trapped in a brutal price war. Investors stand to lose billions of dollars unless a price floor is fixed, and there is fear of bankruptcy. Authorities are hoping that a price floor cartel succeeds. Does this ring a (telecom) bell? Well, it’s not what you think. This market is oil, and the three players are the US, Saudi Arabia and Russia. The US has private shale oil suppliers, while the latter two have state-owned oil companies. Over the weekend, the price of crude dropped precipitously toward $30 a barrel, after the Saudi-led oil cartel failed to agree on production cuts with non-member Russia. US shale oil players, who were not party to the negotiations, were hoping for a cartel agreement, since their very viability depends on higher oil prices. Anything below $50 is bad news for them, especially for the junk bond investors who have financed these shale oil wells. The Saudis, with a vengeance, decided to up the ante, increasing their oil production and offering customers steep discounts, thus effectively trying to muscle into the market share of Russian oil companies in Europe. Russia, which is not a part of the Organization of the Petroleum Exporting Countries (Opec), refused to play ball on production cuts because its oil firms seemed bent on hurting US shale oil producers. The price war might very well be a proxy manifestation of a geopolitical showdown in West Asia between a Russia-Iran alliance and a US-Saudi one.

The supply glut comes at a time when there is possibly a negative demand shock caused by the Covid-19 epidemic. Since travel and tourism are badly hit, with a knock-on effect on consumer confidence, oil demand was anyway set to go down this year. Financial and commodity markets foretell a recession-like situation. The virus was an excuse that bloated stock markets needed to deflate, if not purge themselves. Bond rallies are also signalling huge risk aversion. Whether stock and bond prices are spiralling up or down, there’s no telling where nervous markets will stop. Financial markets are prone to overreactions and herd behaviour. It’s only the cold-blooded and somewhat crazy risk-taking contrarians who can wade in with buy positions. This time, contrarians won’t be enough to stop the downward spiral, so expect government interventions, and fiscal and monetary stimuli on a big scale. The US Federal Reserve has already made an unprecedented rate cut.

For India, a big net importer of oil, a low price is good news. It spent $111 billion on oil imports last fiscal year, and the figure for 2019-20 is close to $120 billion so far. Hence, a 20% drop in price over the next fiscal year would save at least $20 billion in foreign exchange. It would also save the Centre another $2.5 billion on oil-related subsidies. Ceteris paribus, this would be like a fiscal stimulus for the economy. But we also have low consumer demand and falling investor sentiment to go with the oil supply glut. So this is a mixed blessing.

Note that a third of India’s annual remittances of $70 billion come from oil-rich West Asia. The price war, even if temporary, spells trouble for India’s diaspora workers. Dubai would be particularly hit since it was counting on an impetus provided by an expo scheduled later this year. If there are layoffs, jobless workers start returning in big numbers, which would be a big negative.

When Prime Minster Narendra Modi took office in 2014, oil prices had crashed by more than 40%, and stayed low for nearly two years. The estimated fiscal bonanza, since excise taxes were kept high, was about 11 trillion. His government chose not to pass on the entire benefit to consumers at petrol pumps. Much of the gains went to plug inherited hidden fiscal gaps and fund infrastructure, apart from bank recapitalization and social sector schemes. In hindsight, that bank recapitalization was inadequate and a little too late. Nevertheless, the economy was in much better shape, with growth of 8% in 2016-17.

By contrast, the economy is in much worse shape today. Consumer and business confidence is low, private investment is stagnating, banking sector woes are mounting, and there’s no fiscal space left. Economic growth and credit flow are both low. Arvind Subramanian, former chief economic adviser, feels that the current situation is not unlike the pre-1991 crisis. This may be needlessly alarmist. Unlike 1991, India’s foreign exchange stock is healthy, inflation is moderate, and the central bank is open to using unorthodox stimulus measures.

So, how best to take advantage of the implied fiscal stimulus of a fall in oil prices? First, note that the volatility in the oil market is extreme, and an upward spike is not ruled out. Hence, the government should authorize forward purchases and lock in the low prices currently available for India’s entire annual requirement. Second, use the improved fisc to provide across-the-board interest rate subventions to small and medium enterprises on healthy loans. Third, clear outstanding dues to all vendors, from all public sector entities and government departments. Fourth, support exports aggressively, especially in textiles, leather, agro-processing and other labour-intensive sectors. Fifth, remove excessive carbon taxation, of which the coal cess survives under the benign new name of a goods and services tax compensation cess. Sixth, unload excess food stocks for the sake of price stability; it would also reduce the food subsidy burden.

A fiscal windfall, even if infected by a virus, is a terrible thing to waste.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution

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