Rising world oil prices may spoil the party for the Modi government just as Budget preparations begin in North Block. Currently, the prices are ruling at about $65 per barrel, far higher than three years ago when the NDA assumed power. It was considered great luck that the external environment proved so balmy for the new regime. It had the cushion of low oil prices, badly needed for a country that has been importing as much as 80 per cent of its consumption. In sharp contrast, the UPA government had to contend with extremely high international prices reaching a peak of $140 per barrel at one point during its tenure. The sharp decline in prices began in 2014, with the prolific output of shale oil from new fields in the US. To add to it, the oil cartel, OPEC, did not make much of an effort to contain the downslide in the hope that shale oil producers would end up finding the low prices uneconomic. The hope turned out to be a vain one. Shale producers kept turning to newer and cheaper technologies to ensure that output remained consistently high and expanded US inventories while simultaneously keeping world prices at rock-bottom levels.
The situation has changed over the last six months. The prices have gradually been edging northwards, pushed by geopolitical tensions as well as production cuts imposed by OPEC. The tension between North Korea and the US has been one of the triggers for higher prices, as oil is a strategic commodity that will become precious in case of any international conflict. OPEC has also managed to ensure that output quotas laid down for its members are actually followed rather than flouted. In the past, these have been exceeded by some countries which needed to earn more revenues from oil sales. This time around, some leeway has been given to countries like Libya and Nigeria which are facing internal conflicts. In addition, the production cuts have included major non-OPEC producers like Russia which joined hands with the cartel last year. It has now agreed to continue the production cuts till June next year.
It has been this kind of cooperation between OPEC leader Saudi Arabia and Russia that has pushed world prices from less than $40 per barrel to $65 per barrel of the benchmark Brent crude within two years. The price of the Indian basket of imported crude oils will be slightly lower.
The question is: what will be the impact on the Indian economy? The simple answer is: it will wreak havoc on GDP growth. The RBI has estimated that a $10 rise in oil prices will reduce growth by 0.15 per cent. Similarly, Japanese financial services company, Nomura, is quoted as saying that rising oil prices will push up inflation and weaken growth. It will also affect corporate earnings. The economy has just recovered from a downslide over five quarters that culminated in 5.7 per cent growth in the April-June period in 2017. This was followed by a rebound in the July to September quarter, prompting predictions of India being on recovery mode. Projections of 7 to 7.5 per cent growth are being made for the next fiscal. The happy bubble is likely to burst in case oil prices remain consistently high for the next few months.
The RBI has been basing its growth projections on the Indian crude oil basket being pegged at around $55 a barrel. In case crude oil prices continue to remain beyond $60 and even breach the $70 mark, as is being predicted, it would mean that economic growth would slow down considerably. It has to be remembered that with most of crude oil needs being imported, this will lead to a huge increase in the oil import bill. It is projected to go up to nearly $90 billion this year from $72 billion in the last fiscal, and an even lower $64 billion in 2015-16. Besides, the government will probably have to forego the windfall revenues from excise duties that were possible when oil prices had fallen from $114 in 2014 to $47 in January 2015. Unless there is a cut in excise and customs duties, the cost of oil to consumers will shoot up enormously. It will also push up inflation. The NDA will then face flak at a time when it has to gear up to face a series of state Assembly elections.
In case the cost of higher oil prices is passed through to consumers, it could also impact industry significantly. This could affect the revival of corporate earnings that have been anticipated due to the upswing in economic growth.
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