FPIs may find India attractive as oil prices fall, fundamentals improve

Foreign investors may come back to India because of the fall in oil prices and the improvement in the domestic fundamentals, but that could happen only after they make sure the oil correction is here to stay and India’s deficits are bridged.

The crude oil price for the Indian basket has averaged $74/barrel (bbl) in the current financial year. The rupee-dollar exchange rate has averaged Rs 69.6 a dollar. 

In the Budget 2018-19 (FY19), the petroleum and finance ministries had calculated the oil import bill to be $105 billion on the assumption that the international oil basket would average $65/bbl and the exchange rate Rs 65 a dollar over the financial year. 

In October this year, the petroleum ministry gave a revised import bill estimate of $125 billion — a rise of $20 billion — if oil averaged $77.9/bbl and the rupee 72.2 to the dollar over the second half (H2) of FY19. 

If Brent crude falls and the rupee appreciates to some extent, the import bill could be somewhere between $105 billion and $125 billion for the financial year, but closer to the latter, analysts said.

A month ago, surging oil prices had become the biggest headwind for the Indian markets. An unprecedented 30 per cent drop in Brent crude to below $60 per barrel is now seen as a major boost to the economy.

However, experts say the positive impact of the oil price drop on the economy and earnings will play out in the medium to long term. In the near-term, they say the markets may not rally much purely on account of the oil price crash.

“The market has largely reacted to the oil price fall. There may not be any incremental takeaway. The latest price fall may not be a good enough reason for the market to change direction in a big way,” said U R Bhat, managing director, Dalton Capital Advisors.

The primary reason why investors would like to wait is that the fall in oil prices seems to be on concerns surrounding oversupply owing to higher output and weaker sanctions on Iran. However, there are also concerns about global growth weakening.

“Lower oil prices, if sustained, improve India’s macroeconomic outlook. However, there are concerns about global demand outlook, which, in turn, can keep risk appetite contained. Thus, sustaining the recent revival in foreign portfolio investment (FPI) flows needs to be monitored,” said Anubhuti Sahay, India chief economist, Standard Chartered Bank. “The market had corrected 15 per cent from its peak. It has rebounded 5 per cent from the bottom. We have seen foreign institutional investors’ flows improving as the markets had declined to attractive levels. But the markets still uncertainty, due to which it is difficult for them to scale back to historic highs,” Bhat said.

Siddhartha Sanyal, chief economist India, Barclays Bank, said: “In terms of FPI flows, an oil price fall would make the local macro fundamentals look better. In the absence of other major global headwinds, this should help the FPI inflows to resume. Nevertheless, Assembly election results on December 11 is an important event to watch.” 

In November so far, FPI inflows have been positive in the debt segment, whereas in equities they have been marginally negative. Overall, in the month so far, net inflows have been Rs 56.42 billion, against Rs 389.06 billion net outflows in October. Most global markets fell along with the drop in oil prices on Friday, when the Indian markets were closed.

Impact on deficits

The fall in crude oil prices is good news for the Centre and the RBI, which will announce monetary policy on December 5. Lower oil prices soften the current account deficit (CAD) and the fiscal deficit whereas the rupee gains strength as inflows improve. “Our analysis shows for every $10 movement in oil prices, India’s current account balance is affected by 40-50 bps. So, the biggest impact of the oil price drop would be on the CAD,” said Sanyal. India’s CAD has widened to 2.5 per cent of GDP on account of higher crude oil prices, against just about 1.5 per cent in fiscal 2017. 

Softer oil prices will have “positive implications for the balance of payments and the rupee. Higher oil prices mean a cut in excise collection, thus, lower revenue, or higher inflation rates. Thus, with oil price correcting, fiscal and inflation risks subside as well,” Sanyal said. Analysts say for every dollar rise in the crude oil price, India’s oil import bill rises by $0.5 billion ($500 million). 

As to the revenue to the Centre, fuel excise duties are applied on finished products — petrol and diesel — at the retail level and at a fixed rate. Thus, changes in oil prices or in the rupee-dollar exchange rate do not impact revenue collection on account of these duties. Two factors — the consumption of the two fuels and the fixed rate per litre of the excise duties — affect excise revenues. With the reduction of Rs 1.5/litre in the basic excise duty in October, the government would forgo Rs 105 billion on account of fuel revenues. Assuming that the consumption grows at the natural rate, it is only if crude oil prices jump through the roof again, would the government be compelled to reduce excise duty rates before the election, and take a hit on its revenues? 

Alternatively, if the crude oil price remains low, but the domestic consumption of petrol and diesel rises above expectations, the government might be able to reduce the revenue shave-off. As distinct from the Centre, states apply a mix of ad valorem value-added tax and a fixed rate cess/tax on petrol and diesel. Higher oil prices in the first half of FY19 have benefited several states in terms of revenue. If crude oil prices fall in H2, the revenue to states would reduce to some extent. But if Brent futures are anything to go by, there is little to worry for the central government. As of November 24, ICE Brent futures for January-March 2019 stand near $60/bbl. Experts think the slowdown in global growth would be partially responsible for the fall. 

If this holds good over the next few months, while, on the one hand, it could obviate the need to reduce excise duties, on the other, it would reduce the import bill, and ease the pressure on the CAD, and help in the rupee’s stability.