Oil prices have been headed south for the last six months. At the time of writing the article, crude oil price is $45 per barrel as against $105 per barrel in 2013-2014. We will keep our discussion restricted to India only. We will try to learn the pros and cons of falling oil prices in India. Before getting on to the impacts of falling oil prices on India, let us first understand why crude oil prices are declining sharply. Oil prices are determined by the demand and supply of oil. It also depends on the expectations of the producers as well as consumers. Demand of a country depends on the economic activities of their respective countries. It rises in winters in northern hemisphere and in summers, it rises in the countries using air conditioners. Supply is generally affected by the weather and by geo political upsets. Also, if producers expect that demand for oil will rise in the near future, they started investing in exploring and procuring oil. Organisation of Petroleum and Exporting Countries (OPEC)’s decisions shape expectations: If such countries reduces supply, prices can increase sharply. OPEC consists of 12 countries, some of which are Algeria, Iraq, Iran, Libya, Kuwait, Qatar, and Saudi Arabia. Thus, following can be the main reasons which have led to falling oil prices and increasing the possibility of another global recession:-
- Demand is low because of weak economic activities, increase in efficiency and also switching to many other alternatives of oil.
- America is becoming a major oil producer. As of now it hasn’t started exporting oil but it has started importing less of oil which is creating a large amount of spare supply.
- Saudis and other gulf countries are denying to reduce their market share to restore oil prices. This is because it will give other countries such as Iran and Russia an opportunity to tap their niche market.
The only way out to increase the oil prices is to curb supply but many countries are reluctant to do so because they fear that their market share will be foregone. Like Saudi Arabia had $900 billion of reserves and thus, it can survive for some time at such a low prices of crude oil. But this is not the case with many countries like India, Russia, etc. Let us analyze the effect of falling oil prices on India.
Impact on India
Every coin has two sides. Similarly, every aspect can have its effect both in positive as well as negative way. Fall in oil prices affects India in both positive as well as negative way. As we move down further, article will explain how fall in oil prices can be advantageous to many emerging markets like India.
- Oil is very critical for India. Since, India is not self-sufficient in producing oil. It has to import large amount of oil. India imports more than 2/3 of its requirements which makes it that India’s oil imports accounts for approx. 37 percent of total imports. A one dollar fall in the oil price saves around 40 billion rupees. This means that fall in oil prices is having a threefold positive impact on India.
- If in 2014-2015, average fall in crude oil prices is approx. $4, trade deficit will shrink by $3 billion. Current account deficit has reduced to $10 billon which is about 0.48% of GDP, mainly due to customs duty on gold prices. Also, due to fall in prices has also reduced current account deficit of the country.
- Fall in international oil prices will reduce subsidies that help sustain the domestic prices of oil products. This will further help in deregulation of diesel prices which is positive for India.
- Fall in international oil prices will soothe inflation. Although, it won’t help in soothing inflation in India very much because consumption of oil in industry in not that high except in the manufacture of certain products such as carbon black. A 10% fall in crude oil prices could reduce CPI inflation by 20 basis points (bps) and bring about 30 bps rise in GDP growth.
- Soothing inflation will also give RBI an opportunity to cut interest rates, providing more flexibility in budget and fiscal management.
Thus, above mentioned were the positives of fall in oil prices. But, there is flip side too for the same. The sharp and immediate fall in crude oil prices has deeper implications on markets and the way businesses and companies operate. Falling in oil price not only effect India but also many other countries. Below mentioned are the ways which will impact India in a negative way:-
- $2 trillion of bank funding is involved in oil exploration and production activities. With falling crude oil prices to around $45 per barrel, many projects are facing viability issues. When this unviability goes for a very long period of time, many companies may go bankrupt.
- Many countries are being impacted in negative way due to fall in crude oil prices. It includes large economies such as Russia, Venezuela, etc. All these signal that there will be a global economic slowdown which further will impact trade between the countries.
- India is heavily dependent on Foreign Institutional Investors (FII) and Foreign Direct Investment (FDI) inflows. Global economies growing at slower rate will further impact India in terms of failure of “Make in India” campaign and Sensex which has even crossed 29000 mark.
- Several Indian companies have business deals with foreign oil majors. Unviable prices will affect their cash flows which will impact India as a whole economy. In India, companies active in the business of polymers, and other crude oil derivatives are stuck with high cost inventories.
- Fall in oil prices is also impacting domestic exploration companies such as ONGC. Every one dollar per barrel drop in crude price trims annual net revenue by roughly Rs.800 crore and net profit also falls by Rs.450-475 crore. Analysts believe that cushion provided by increase in gas price and reforms in oil subsidies may still not be sufficient to ensure same net realization of ONGC’s Profits.
Thus, falling oil prices is impacting India in both positive as well as negative way. However, India can gain more form falling oil prices by storing huge amount of oil like China has already started doing the same. Even if oil price goes slightly lower than $45 it is not a big negative but it does imply that there is going to be a lot of weakness in external demand and countries in Latin America like Venezuela which already have a very difficult situation, emerging markets like Russia plus some of the European economies like the UK and Norway that rely on oil exports to a significant extent are going to be facing fairly difficult situations. Fall in oil exports will affect their budgets and their current account balances which in turn will affect their consumption demand. So in the long term, softness in consumption demand is ultimately not good for anybody in the world including India.
But as far as India is concerned, we can say that it will fuel growth as long as foreign economies are economically fit enough and their falling revenues will not lead to global recession.
By: Ashana Mittal