Markets can ignore Iraq turmoil if oil stays below $120

CAD to remain below 3% even if crude oil averages $115 a barrel

Brent crude oil has hit a nine-month high of $114.57 a barrel, as Sunni jihadists started capturing several parts of Iraq this month. Oil prices have remained benign over the past couple of years, which has helped importing countries such as India.

Brent crude has traded in a narrow band of $108-112/barrel for the past 10 quarters and deviated from it only on three other occasions. With Brent breaking out its narrow trading band, many are quick to term this event the next oil shock. Global analysts and strategists are not as worried about the spike in oil prices because these might not sustain. Also, India is better prepared to handle higher crude prices now than even a year ago.

Markets can ignore the mayhem in West Asia, says CLSA's Christopher Wood, if oil remains below the lofty $120-a-barrel level. Barclays Commodity Research says although fundamentals are tightening, geopolitical threats are high and crude oil prices are moving higher again, a permanent move back to a more volatile price regime in oil seems unlikely  any time soon.

However, higher oil prices could wreak havoc on India's balance of payments. The price of India's crude basket has already risen from $106.88 a barrel at the start of June to $110.54 on June 13. Iraq is India's second-largest supplier of crude after Saudi Arabia. But economists are not that worried: thanks to the sharp clamp on imports last year, the current account can deal with a higher oil import bill without triggering a mini currency crisis. In FY15, India's oil imports would increase 2.4 per cent to $171.6 billion if oil prices remained at $106 and the rupee at 60.5 against the dollar. However, if oil prices averages at $111 and the rupee depreciates to 62 against the dollar, the current account deficit (CAD) would widen to $50.6 billion or 2.3 per cent of the gross domestic product (GDP).

Saumya Kanti Ghosh, chief economic adviser at State Bank of India, says even if the prices move up to $115, CAD would be below three per cent of GDP. Also, most of Iraq's oil facilities are in the south and under the government's control. All these factors suggest India’s CAD may not see a significant impact.