What do higher oil prices mean for India?

Oil prices have slipped from the two-year highs hit last week by both crude benchmarks on signs that US supply is rising and could potentially undermine OPEC's efforts to tighten the market. This author discusses the macro sensitivity of India to movement in global crude oil prices.

Brent crude oil prices have continued to recover and are now exceeding US$60/bbl. This is up about 35% from this year's low, and 10% above our 2018 forecast of US$55/bbl. According to our global oil team, oil prices have responded to: 1) the drop in global oil inventories, with the US alone having shed about 80m barrels since the peak reached in March 2017; 2) expectations for an extension of OPEC production cuts; and 3) a stagnant and modestly falling US oil rig count.

Oil price moving up—when does it start hurting India? 

Considering India is a net oil importer with inelastic demand, movement in global crude oil prices tend to have an important bearing on the macro stability risks (inflation, current account deficit [CAD] and fiscal deficit) and hence economic growth prospects. If the Brent price averages around US$60/bbl in FY18 (versus US$55/bbl UBS estimate), the macro stability risks will widen but will still be manageable. The Monetary Policy Committee (MPC) would prefer to go in for a prolonged pause (versus scope of one more 25bp rate cut priced in as per our base case, assuming a stable fiscal position). However, strengthening in oil prices above US$70-75/bbl could lead to terms of trade shock and could have a significant impact on growth, inflation, CAD and fiscal balance. In such a scenario, there is a risk of further tightening in policy rates. Let's discuss the macro sensitivity of India to movement in global crude oil prices.

a) Oil imports and current account deficit (CAD) 

India imports 82% of its oil requirements and net oil imports stood at US$56bn (2.5% of GDP) as of FY17. According to PPAC (Petroleum Planning & Analysis Cell), a US$10/bbl rise in oil prices increases India’s import bill and, hence, CAD by US$8bn (0.3% of GDP).

b) Oil subsidy, excise duty and fiscal balance 

India’s gross under-recoveries in oil have narrowed to around US$3bn (0.12% of GDP) in FY17 from the peak of US$30bn (1.6% of GDP) registered in FY13, due to a sharp fall in global crude oil prices and energy sector reforms that helped lower the subsidy burden. Measures undertaken by the government include the deregulation of diesel prices, modest monthly increases in kerosene and LPG cylinders prices, allocation and distribution reforms (eg, direct benefit transfer), among others. At the same time, frequent hikes in the excise duty on gasoline and diesel have boosted the government’s revenue collection but reduced the direct gains to consumers from lower crude oil prices. However, this is now reversing as oil prices have begun moving up. According to PPAC, a US$10/bbl increase in global crude oil price increases India’s fuel oil subsidy by about US$2bn (0.08% of GDP) if domestic fuel prices are unchanged (assuming USD/INR remains stable). Correspondingly, every Rs1/litre cut in excise duty reduces government’s revenue collections by US$2bn (0.1% of GDP).

c) Inflation 

Petrol and diesel have a combined weight of 2.3% in the CPI basket. A 10% rise in crude oil prices could increase CPI inflation by around 25bp, if the government were to pass the full increase to consumers (a cascading impact of a similar magnitude would also be felt). A possible excise duty cut in petrol and diesel to provide relief to consumers in lieu of higher oil prices might help soften the impact on inflation. 

d) Private consumption and growth 

A 10% increase in average crude oil prices would result in a 30bp dent in GDP growth if the full cost were passed on to consumers (RBI’s estimates). However, the impact would be non-linear of a subsequent increase in oil prices. 

The author is an Economist at UBS Securities India Pvt. Ltd