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The Good Days Are Over: The Indian Economy has an Oil Problem

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When Prime Minister Narendra Modi assumed office in 2014, the price of crude oil was an astronomical $106.85 per barrel. To his great fortune, in a short period of 15 months, the price would fall to an all-time low of $28.08 per barrel, with India’s import bill dropping a little over $75 billion between 2013–2014 and 2016–2017. Capitalising on this bonanza, the government would continue to impose an excise duty and VAT on petrol and diesel to further boost its revenues.

Unfortunately, the government’s days of luck might have run out. Last month, the international benchmark for oil prices, Brent, crossed $80 a barrel. Fuelled by OPEC’s voluntary supply cuts, President Donald Trump’s sanctions on Iran and geopolitical tension in Venezuela, have collectively ensured a sixth straight week of gains in oil price. For a country like India that imports over 80% of its oil, this development is expected to add $25-$50 billion to its import bill.

Oil pricing is dependant on a number of variables. However, the geopolitical climate and supply side constraints in producer nations are easily the most vital. Hence, in an ideal scenario though increasingly unlikely, if the present situation the Middle East dramatically improved and Europe can somehow salvage the Iran Deal while Nigeria and Venezuela managed their disruptions, energy analysts are optimistic that oil price could fall back to $60 per barrel in the coming months.

Iran currently exports about 2.2 million barrels per day. China and India are expected to maintain their arrangement with Iran and might even be able to negotiate a better deal for themselves, with the promise to shield Iran from the worst effects of the sanctions. However, both countries are facing increasing pressure from the US to comply with sanctions. Europe has also voiced its displeasure on American sanctions and if the European Union continues to do business with Iran, the negative effects on the supply side might be limited.

Going forward, on the supply side, a lot is contingent on how quickly the US can increase its shale gas production. Till 2014, shale was touted as the answer to America’s growing energy needs. However, with a dramatic decline in crude oil price, the economic case for shale quickly diminished and production declined. With crude oil prices hovering below $50 per barrel for the longest period, production of shale was simply unviable. At the current price of crude oil, production of shale is greatly profitable. Speculation that demand will exceed supply in the US this summer driving season, could see the production of shale gas being quickly ramped up.

Globally, OPEC’s moves will also be watched very closely in the coming months. Will OPEC come together and make up for some of the shortfall caused by sanctions on Iran and potential sanctions on Venezuela? Or will Saudi Arabia use this opportunity to further it’s own ambitions- lest we forget, the higher the price of oil, the better it is for the upcoming Saudi Aramco IPO. For now, Saudi Arabia’s official position is that it is open to increasing oil output but will do so only after consulting with OPEC and Russia.

Oil prices could go either way and India has to be prepared for the worst. Traders have not ruled out the possibility of oil prices breaching the $100 mark in the next three to six months. For India, oil price at a $100 per barrel in a pre-election year is nothing short of a political and economic nightmare. With several key states slated to go to the polls later in November, the oil marketing companies might be forced to bear a significant portion of the burden, as they have had to in the past.

In the state of Karnataka, the government was not willing to increase petrol and diesel prices for two weeks in the lead up to the elections. Since the election, the prices of petrol and diesel have been hiked everyday, for fifteen days in a row followed by a one paisa cut. Political realities often take precedence over the economic ones. Can the government afford such luxuries later in the year if oil is priced at $100 per barrel? Only time will tell.

At $100 a barrel, strong inflationary forces will settle into the Indian economy. If recent Economic Survey estimates are to go by, every $10 per barrel (bbl) hike in oil price pushes India’s import bill up by $8 billion. Furthermore, GDP growth goes down by 0.2–0.3 percentage points, current account deficit increases by 0.4 percentage points and wholesale inflation goes up by 1.7 percentage points.

A weakening rupee and capital flight from foreign portfolio investors is also bound to aggravate the problem further. According to RBI data, reserves have already shrunk by $5.7 billion in the last two weeks as investors have withdrawn their portfolio investments over concerns of India’s current account deficit. Some market estimates warn that this year, India could see permanent foreign currency outflow to the tune of $45 billion.

At the current price of $75-$80 a barrel, trade deficit and current account deficit will be severely affected and whatever little of the strong recovery that we saw at the beginning of this year might even out. The 2018–19 budget has assumed an average crude oil price of $65 per barrel for the year and there might be no reason to panic just yet. However, as the IEA points out in its Oil Market report, India has just about started to recover from the prolonged demonetisation and GST woes and cannot afford another slowdown.

For now, India would be desperately hoping for some alignment in geopolitical interests. In an ideal scenario, if price falls back to $60 a barrel, the Indian economy would have lived to fight another day.

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