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In July, Brent crude oil prices were around $115/ barrel. Last week, the price fell to $85. This steep 25 per cent correction has been triggered by consensus expectations that gross domestic product growth across the globe will be very slow. At the same time, the US has ramped up crude and gas production through the "frakking" of tight oil and shale.
This combination of events has altered the global fuel supply-demand equation. Demand is sluggish and supply is rising fast. Supply will exceed demand through the near future and supply may continue to grow faster than demand for quite a while, at least until the global economy regains momentum. Crude prices could stay soft through the 2014-15 winter and maybe through next year as well.
The market seems to have factored in sanctions against Russia, the battle in Iraq and Syria against ISIS and the natural increase in demand for heating oil during the Northern winter. Despite the war, Iraq could be capable of bringing more capacity on-stream and now that the US and UK have committed to action against ISIS, the situation could improve for Iraq in military terms. A bonus could be Iran coming back into the international markets if sanctions against her are lifted.
Assuming the consensus expectations are right, there are multiple implications for India. The good implications are easy to spot. As a major fuel importer, India gains a lot if crude prices see a falling trend. The trade balance and the current account will both remain under control.
The fiscal deficit will be reduced because retail subsidies will not be required or at least, can be phased down. International coal and gas prices (which are also dropping) will probably continue to cool off in line with crude prices.
Domestic inflation will cool off because transport costs will drop. In turn, this will give the railways, and other transporters, a chance to realise higher margins. If the government takes its chances, it can also decontrol diesel and kerosene in this window of opportunity. If the government has sufficient courage, it can cut the gas subsidy and free gas prices as well. Or at least, the government could work out some sane mechanical formula that can be used to price gas in future. This is expected by mid-November, now that the assembly elections are over.
It is likely the desperate situation in the power sector will improve. If coal and gas imports are priced lower, some power generators may be able to engineer a turnaround, which means banks with sticky exposures will be relieved. The public sector oil-marketers will see a reduction of stress on their respective balance sheets. Even producers like ONGC and OIL will be relieved since they won't have to bear a subsidy burden for the under-recoveries of BPCL and HPCL.
So far, so good. The negative aspects are more difficult to quantify. In a global slowdown, Indian exports will also be hurt. There may also be a drop in the inflow of investments, be it FDI or FII. Even rock-solid government-to-government commitments can founder in a severe global downturn. There could be various negative impacts of this nature.
India has struggled to maintain GDP growth and a stable fiscal balance with manageable deficits when crude prices have trended up. India has generally done well in terms of both growth and deficits when crude prices have been in a sweet spot. However, India struggled to maintain growth after the 2008 subprime meltdown when investment from abroad dipped. GDP growth was maintained only via huge pump-priming ( through government spending) which led to ballooning deficits.
One interesting consequence of sustained FII selling would be the likely fall of the rupee. A cheaper rupee would compensate to some extent for weak export demand. Again, this is hard to quantify. There could be multiple scenarios for India's macro-economic growth playing out over the next year to 18 months. The model will depend on personal assumptions of critical variables. The consensus opinion seems to be that lower crude prices should be good, despite likely slowdowns in FDI inflow and low FII investments or net FII selling. In most of these scenarios however, the short to medium term effect on the stock market could be bearish. FII selling usually pushes index values down. If the fundamentals get better at the same time that prices correct down, there will be a good opportunity for the long-term investor.
