India’s economy on the rise as oil price drops

The commodity’s decline has been a windfall to the country’s government, businesses and consumers, who have been freed from the constraints of high fuel subsidies and transport costs.

Providing affordable fuel in India, where two-thirds of the population live on less than $2 a day, has been a huge financial burden for the government. Above, a petrol pump in Hyderabad. Krishnendu HaShow more

The slump in oil prices is providing a boost for India as the country emerges from its worst economic slowdown in decades.

“India, which is one of the biggest importers of crude oil in the world, is one of the biggest beneficiaries of the fall in crude oil prices,” says Sakthi Prakaash, the lead research analyst at WealthRays Securities, a broking, research, and corporate advisory firm based in Bangalore.

Oil prices have dropped to five-and-a-half-year lows below US$46 a barrel this month amid oversupply. India is benefiting from sharply reduced import costs and inflation as a result.

The country was the world’s fourth-largest consumer and importer of crude oil in 2013, according to the US Energy Information Administration (EIA). Its petroleum product demand reached almost 3.7 million barrels per day, while the country only produced at about 1 million barrels per day, according to the agency.

Each decrease in the oil price by US$1 results in a 40 billion rupee (Dh2.38bn) drop in the government's oil import bill. Oil makes up more than a third of India's total imports.

And the country’s energy demands are continuously growing as its economy expands and modernisation continues.

The EIA expects Indian demand to more than double to 8.2 million bpd by 2040, while it forecasts that domestic production will remain stagnant.

Heavy government subsidies of fuel for households and a large import bill mean that a decline in oil prices reduces the trade and fiscal deficits for the country.

The fall in oil prices come as a welcome relief to households, with benefits including lower prices at the petrol pump.

“For a country going through a five-year cycle of rising inflation, this is indeed good news, and the longer it lasts the better for consumption, investment, government expenditure and the current account,” says Kamal Sen, the president and chief executive of Cogitaas, a consultancy.

As well as bringing costs down of oil products directly, it also has a knock-on effect in reducing on the cost of other goods for households, including food.

“Reduction in transport costs – particularly of perishables – should help control inflation, especially for those items where inflation was very high,” says Mr Sen.

The Reserve Bank of India on January 16 announced a surprise interest rate cut, trimming the key repo rate by 25 basis points to 7.75 per cent. Lower oil prices played a major role in creating headroom for the central bank to make such a move, with the wholesale price index, the main gauge of inflation, rising last month by just 0.11 per cent compared with December 2013.

Soaring inflation has been a major headache over the past few years and meant that interest rates remained high. Further rate cuts are expected this year, bringing down the cost of borrowing, which encourages consumer spending and brings the price of loans down for businesses.

“The reduction in oil prices is bringing down commodity prices,” says Mr Sen. “This would reduce costs for industrial growth. India’s export basket is not heavily weighted towards commodities, so India should not face the problems that exporters of commodities are facing.”

Providing affordable fuel in India, where two-thirds of the population live on less than $2 a day, has been a major challenge and financial burden for the country over the years.

“Most of India’s demand is for motor gasoline and gasoil, fuels used mainly in the transportation and industrial sectors, and for kerosene and propane,” according to the EIA.

“Consumers receive large subsidies for retail purchases of propane and kerosene, placing upwards pressure on overall oil demand. Insufficient investment in developing more crude oil and liquids production has caused production to grow at a slower rate than oil demand.”

The Middle East is India’s major source of crude oil, followed the Americas – primarily Venezuela – and Africa.

“Lower crude oil prices have reduced the expenditure significantly for the government, which in turn has reduced the current account deficit for the country,” says Mr Prakaash. “Lower oil prices is also an opportunity for the government to provide subsidies for struggling sectors, which in turn can foster economic growth.”

The finance group Nomura has predicted that India could post its first current account surplus for more than seven years this quarter because of the slump in oil import costs.

Asheet Pasricha, the president of the Association of Indian Forging Industry, says he would not like to see oil prices fall much further because of the global fallout that would result. But with oil prices at their current low levels, the situation is certainly positive for India’s economy, he says.

“Specifically to the manufacturing sector, the price fall is expected to assist in a much-needed turnaround by way of lower energy costs,” says Mr Pasricha. “The hope is that this will mean increased demand for automotive vehicles across passenger, two- wheeler and commercial, which in turn will fuel the overall growth of this sector and the allied industries that depend on it.”

The airline industry is another sector that benefits from the fall in oil prices because one of its major expenses, fuel, decreases.

Mr Prakaash, however, points out there are companies in India that are negatively affected by lower oil prices.

“The companies that will be significantly affected by the fall in crude oil prices are oil-producing companies such as ONGC and Cairn India, whose revenues would get hit because of the drop in crude oil prices,” he says.

Reliance Industries, one of India’s biggest conglomerates, this month reported a 4.5 per cent drop in net profit because the decline in oil prices hit the profitability of its refining operations.

“This was a tough quarter,” said Alok Agarwal, the chief financial officer at Reliance Industries, as reported in Business Standard, an Indian financial newspaper. “In the commodities business, this kind of volatility leads to a lot of challenges in terms of making sure margins do not get pressured.”

A further slide in oil prices would present other risks for India, says Mr Prakaash. These include market volatility, which could eventually affect foreign investment flows into India, while oil projects could be shut down and oil exploration projects could be stopped, he says.

India in a sense has been fortunate that lower oil prices are offering the country some relief at the moment, but Narendra Modi’s BJP government faces the challenge of working on longer-term solutions to its costly expenditure and dependence on the commodity. This could include development of alternatives, including renewable energy sources.

“In the long term, the government needs to fix the rate of excise duty instead of ad hoc increases, which is what India Inc has been protesting,” says Mr Pasricha. “This will enable the government to achieve its fiscal deficit targets and help contain the impact of international crude price movement on domestic users, when they start rising again, thereby mitigating the impact of inflation.”

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