Crude oil up to $65 a barrel not a worry

However, it's already touched $64 a barrel in lieu of recent developments in Saudi Arabia

With crude oil crossing $64 a barrel on the developments in Saudi Arabia, this country's current account deficit (CAD) could see a little more pressure. 

However, the expectation is that this could be financed easily, as capital flows, particularly on the debt side, are robust and will not trigger huge withdrawal from the foreign exchange reserves. These had widened to a four-year high of 2.4 per cent of Gross Domestic Product (GDP) in the first quarter of the current financial year.

There should not, say those in the know, be a problem up to a crude oil price of $65 a barrel. However, beyond this level, controlling the CAD could be a problem. 

Aditi Nayar, principal economist at ratings agency ICRA, says her baseline projection for the CAD is $35 billion (Rs 2.26 lakh crore) for 2017-18. It was $14.3 bn in the first quarter.  

"This assumes oil at $60 in November and December and between $55 and $58 from Jan to March. Even if we take crude to average $60 in the past three months, the impact on the CAD will only be to the extent of around $1.3 bn," says Nayar.

Suvodeep Rakshit, economist with Kotak Institutional Equities, says for every $1 rise in crude prices, the impact on the CAD is likely to be around $1 bn. "Even if average crude prices rise by $5, the CAD will be manageable because of the sharp spurt in capital flows that we are seeing, especially in the debt segment. Thus, any adverse impact on the rupee is likely to be limited," he says.

CARE Ratings, however, thinks forex reserves could come under pressure if oil remains above $60 a barrel. A note it has issued says with import of 1,575 million barrels of crude oil on an annualised basis, a dollar increase in prices on a permanent basis would increase the yearly bill by roughly $1.6 bn or Rs 10,000 crore. In FY17, it says, the oil import bill was $86 bn, with physical imports of 215 mn tonnes, averaging at $55 a barrel. 

"If prices do reign above $60 a barrel, there would be pressure on the import bill by $8-10 bn. As the trade deficit has been widening of late, at $74.3 bn for the first six months compared with $43 bn last year, the balance of payments would be pressurised," it says.

Rakshit says the impact of rising crude on retail inflation is likely to be muted in the short term, as petrol and diesel have a combined weightage of only 2.5 per cent in the index. "So, even a 10 per cent increase in prices might not have that adverse an impact on overall inflation."

On wholesale price inflation (WPI), though, the impact will be slightly higher because it has a higher weightage, he says. Adding: "Higher crude prices translate to higher input costs. So, corporates could see some compression in margins."

Since the current method of calculating GDP takes into account value addition or margins of companies, this would be affected to an extent. 

Nayar says the impact on WPI inflation is difficult to estimate. In July 2017, when the Indian crude oil basket averaged Rs 3,085 a barrel, the crude oil index in the WPI was at 55.6 points. In September, when the basket had increased to Rs 3,500, the initial level of the index was again estimated at 55.6 points.

The note by CARE says with state duties on oil being ad valorem, the final impact on WPI inflation would be higher than the change in crude prices. A 10 per cent increase in crude oil prices would lead to a 0.5-0.7 per cent increase in WPI directly.

In terms of CPI, it says a lot depends on how prices react at the retail level. Petrol, diesel and cooking gas have a weight of 2.4 per cent and transport based on such fuel at 1.9 per cent. Full transmission of a 10 per cent increase could increase the final price by seven or eight per cent and CPI inflation by up to 0.3-0.35 per cent. 

The finance ministry is struggling hard to rein in the Centre's fiscal deficit, which has crossed  90 per cent of the year's budgeted total in six months. The ministry assumed crude at $60 while preparing the Budget for FY18. However, officials in the ministry say the deficit would not come under major pressure if prices don't go beyond $65 a barrel. 

Nayar says the government's revenues will come under pressure only if it chooses to again cut the excise duty on petrol and diesel. 

Nomura, the global financial services major, says every $10 per barrel rise in the price will worsen the fiscal balance by 0.1 per cent of GDP.