Lower Oil Prices Boon For India’s Twin Deficits If Not Consumers

The sudden plunge in crude oil prices may benefit government finances and India’s external indicators even if consumers see only a limited impact of lower retail fuel costs.

Brent crude tumbled 32 percent to $34 per barrel on March 4 from $50 per barrel on Feb.28 due to the twin impact of the spreading coronavirus and the stand-off between Saudi Arabia and Russia. Together, the two factors could mean increased supply of oil at a time of lower demand.

Brent crude prices rebounded marginally from lows to trade close to $37 per barrel on Wednesday. Should oil prices remain low, India’s twin deficit could narrow, said economists.

Lower oil prices provide significant tailwinds to the Indian economy in the form of a lower current account, lower inflation and improved government finances/household savings, said Kotak Institutional Equities in a note on Wednesday.

CAD To Fall

A fall in crude price lowers both the trade deficit and, in turn, the current account deficit since India largely relies on imports for its oil demand.

The nation imported $87 billion in petroleum products, while exports accounted for $35 billion million between April 2019 and January 2020. As India remains a net importer of petroleum products, current account deficit will remain the main beneficiary of the fall in crude oil prices, said Devendra Pant, chief economist and head of public finance at India Ratings and Research.

Global crude prices are likely to remain under pressure. According to a research note by Kotak Institutional Equities, the prevailing global oil surplus is expected to exacerbate due to a contraction in demand amid Covid-19 and the inability of the OPEC+ cartel to agree on an appropriate production cut.

If oil remains at $35 a barrel, the current account would narrow virtually to balance for the first time since 2003-4, said JPMorgan economists in a recent report. Whether the balance of payments widens would depend on the extent of capital outflows given the global risk off scenario and flight to safety, it added.

More Fiscal Headroom

The impact of crude on the fiscal deficit has reduced over time as the government no longer subsidises petroleum and diesel. It does still subsidise kerosene and LPG cylinders.

A $10 decline in crude oil prices increases the fiscal headroom by $1.9 billion (approximately Rs 14,000 crore) due to reduction in cooking fuel subsidies, Kotak Institutional Equities said. It could also generate $8.5 billion ( approximately Rs 62,000 crore) of potential revenues from an equivalent Rs 4.5 per litre increase in excise duties on auto fuels, the brokerage house added. No such increase has been announced yet.

While the central government collects excise duty at a fixed price, the state governments collect value-added tax ad valorem or as a percentage of the value of transaction. So theoretically, Pant said, revenue collections could even fall.

The full benefit of cheaper crude will, however, depend on how long it stays at the current levels. For a discernible impact on government finances, crude prices will have to remain low for about two weeks, said Rajni Thakur, economist at RBL Bank.

Economists also say that allowing lower oil prices to pass-through to the consumer at a time of weak demand would be overall beneficial for the economy.

Retail Inflation

India has seen a spike in retail inflation lately, which could moderate due to lower oil-led inflation.

Consumer price inflation and wholesale price inflation see a direct and indirect impact of higher crude oil prices. Fuel and light make up 6.84 percent of the Consumer Price Index, while transport and communication’s weight in the CPI index is 8.59 percent.

According to the Kotak report cited above a $10 per barrel fall in oil prices can lead to a 30 basis point drop in headline inflation.

Lower fuel inflation will help balance out the elevated food prices, which drove headline CPI inflation to 7.59 percent in January 2020. With food inflation expected to ease and demand likely to remain weak, there is a probability of a reduction in general prices as well, said Pant.

The expectation of lower inflation, in turn, could prompt a cut in interest rates from India’s monetary policy committee, economists said.