Lower oil prices to keep inflation under 6%, CAD at 1%

Will also help reduce fiscal deficit by reigning in fuel subsidies

Global crude oil prices are likely to remain subdued for the next two years. This will help India rein in inflation under six per cent as targeted by the Reserve Bank of India (RBI), bring down the current account deficit (CAD) to one per cent of the gross domestic product (GDP), and reduce the fiscal deficit by cutting fuel subsidies.

“India benefits from lower oil prices through lower inflation, an improved trade balance and reduced fuel subsidy costs. Looking ahead, sustained lower oil (and other commodity) prices will support the growth acceleration we expect in 2015 and 2016 by preventing a build-up of inflation and current account deficits,” global research and ratings agency Moody’s said in its latest report.

The price of the Brent crude oil benchmark dropped by about 60 per cent between June 2014 and January 2015, plunging to a six-year low of $47 a barrel in January. Despite a 17 per cent rebound in February to $59 a barrel, Moody’s forecast Brent oil prices will remain at around $55 a barrel in 2015, $65 a barrel in 2016 and $72 a barrel in 2017.

Thanks to the slump in prices, India’s annual fuel and light inflation declined to 3.4 per cent in December 2014 from 6.5 per cent in January 2014, resulting in a drop in consumer price index (CPI) inflation to five per cent from 8.8 per cent. Annual fuel and light inflation will continue to decline during 2015 because of the high base effect.

“Therefore, despite an upside risk to non-oil inflation from food inflation shocks or a return of pricing power as growth rises, we expect CPI inflation to remain well below the RBI’s target of six per cent through January 2016,” said Moody’s Investors Service in its report titled Global Oil Price Shock: Challenges for Oil-Exporting Sovereigns, Breathing Space for Importers.

Lower oil prices will also decrease India’s CAD and, thus, its annual external financing requirements. Petroleum-related products comprise about 30 per cent of India’s merchandise imports and 20 per cent of merchandise exports. A $10 change in oil prices would impact the import bill by $18 billion and lower the trade deficit by 0.8 per cent of the GDP.

In FY14, India’s CAD was recorded at 1.7 per cent of the GDP. Even if export revenues are limited by subdued global growth and non-oil imports increase, lower oil prices are likely to keep CAD at around one per cent of GDP this year, with a few quarterly variations.

Falling oil prices allowed the government to bring about a slew of fuel subsidy reforms in October 2014 - including diesel price deregulation and announcement of a new gas price. A lower fuel subsidy bill will reduce the government’s fiscal deficit estimated at seven per cent of the GDP this year by 0.03 per cent. This muted impact is because fuel subsidies were only 2.7 per cent of government expenditure and 0.5 per cent of the GDP in the last financial year. Lower oil prices have shielded the government’s finances from future fluctuations in commodity prices by allowing the decision to decontrol diesel.

Moody’s also said that in case oil prices decline beyond its forecast to $45 a barrel, inflation would fall further by 3.1 basis points, fiscal deficit would narrow by 0.3 per cent of the GDP, and CAD would improve by another $18 billion. However, if a further fall in oil prices is caused largely due to a global growth shock, its economic benefits would be eroded.

The government had announced a revised figure of petroleum subsidy for the current financial year at Rs 60,000 crore and pegged the subsidy at Rs 30,000 crore for 2015-16 in the Union Budget tabled in Parliament last month. The next financial year’s estimate of petroleum subsidy comprises Rs 22,000 crore towards cooking gas and Rs 8,000 crore for kerosene sales. This fuel subsidy would cover a bulk of the estimated Rs 42,500 crore under-recoveries (the difference between the subsidised selling prices of fuel versus actual costs) of oil firms based on an oil price of $60 a barrel (Rs 55,000 crore if oil averages at $70 a barrel), according to experts.

In 2014-15, the Indian basket of crude oil price has averaged at $89.8 a barrel in the 10 months between April 2014 and January 2015. Oil marketing companies have suffered gross under-recoveries of Rs 67,000 crore in the first three quarters ended December including Rs 10,000 crore losses on diesel, Rs 34,000 crore on cooking gas and Rs 21,000 crore on kerosene sales. The government has borne half of this under-recovery burden.

INDIA BENEFITS FROM SLUMP IN PRICES

• Owing to the slump in prices, India’s annual fuel and light inflation  declined to 3.4% in Dec 2014 from 6.5% in Jan  2014
   
• This resulted in a drop in consumer price index inflation to 5% from 8.8%
   
• Lower oil prices will also decrease India’s CAD
   
• Petroleum-related products comprise about 30% of India’s merchandise imports and 20% of merchandise exports.
   
• Falling oil prices allowed the govt to bring about a slew of fuel  subsidy reforms in Oct 2014, including diesel price deregulation and  announcement of a new gas price
   
• A lower fuel subsidy bill will reduce the govt’s fiscal deficit estimated at seven per cent of the GDP this year by 0.03%