Does India really have to Worry about Rising Oil Prices?

The big story for the Indian economy over the last 2 years has been the dividends from cheap oil. Brent crude fell from a high of $114/bbl in mid-2014 to a low of $28/bbl in Feb 2016. Over the last 8 months, the price of Brent crude has nearly doubled to $54/bbl. In fact, since the OPEC agreed upon supply quotas in its November 30th meet at Vienna, the price of Brent has moved up from $46/bbl to $54/bbl. Here are 3 things that India needs to watch out for in the coming months…

India is a Big Oil Importer…

Against India’s consumption of close to 5 million bpd, it produces just about 1 million barrels of crude per day. Effectively, India is dependent on imports for nearly 80% of its oil consumption. Despite the sharp fall in the price Brent crude, the monthly trade deficit still hovers around $10.5 billion which translates into a full year trade deficit of nearly $130 billion. Currently, India’s forex reserves of $365 billion are sufficient to cover nearly 13 months of imports. This makes India’s external position and its rating very comfortable. The risk is that a 20% rise in the price of Brent crude can seriously impact the trade deficit and therefore the import cover. This could negatively impact India’s external ratings. The sharp fall in oil prices has led to a huge wealth transfer from oil exporters to oil importers. An oil price bounce can lead to a reverse transfer of wealth.

How about Importing Inflation…

The big risk for an economy like India from rising oil prices is the risk of imported inflation. As crude becomes expensive, there are 2 options in front of the government. It can either absorb these losses in the balance sheets of the oil companies or pass on to the consumers. With the government slicing out most of the oil price gains through excise duties, it does not have much leeway. Up to a point, these price hikes will be passed on to the consumer. Beyond that point, the oil companies will have to absorb the cost. Either ways, the net impact will be that inflation will get imported into India. In the process,the CPI inflation will go for a toss.

Markets will take a Big Hit…

Equity market may take a big hit from rising oil prices. Firstly, the oil companies in the upstream and downstream sector will be called upon to share the subsidy burden beyond a point. Secondly, the mid-cap rally in the last 2 years has been largely predicated on cheap oil. That could reverse quite rapidly. Thirdly, in the last 2 quarters, we have seen Indian companies struggling to grow their top-line but expanded their operating profit margins substantially. That could reverse if oil prices start rising. In a nutshell, India could face negative BOP, weak rupee, higher inflation and weak corporate numbers if oil starts to rise again!

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