The rout of crude oil: a double-edged sword

Every coin has two sides, and the rout of crude oil in recent months is no exception. The free fall in the price of Brent crude oil to below $60 a barrel from nearly $115 in mid-June has evoked relief among many in the country. With good reason.

For India, which imports more than three-fourths of its crude oil requirement, the lower price means many benefits. One, it has helped to moderate inflation, the bugbear of the economy over the past few years.

Cheaper input cost for user industries could add the much-needed spring in the step to economic growth. Oil and related products form the largest import component (nearly 36 per cent in 2013-14). So, a lower bill has helped keep the current account deficit in check and prevent a rout of the rupee

It could also help contain the fiscal deficit. The government shares nearly half the under-recovery burden of the oil marketing companies.

The fall in crude oil price has enabled diesel prices to be decontrolled and there is no under-recovery on the fuel currently; the subsidy on domestic LPG and kerosene has fallen sharply as well. This, along with the recent hikes in excise duty on diesel and petrol, means a reduced burden on the exchequer. Clearly, there is much to cheer.

But not all is hunky-dory. The near-halving of crude oil prices, in such a short time-span, is indicative of high stress in the global economy; this has repercussions for India.

Falling crude oil prices are a combination of improved supplies (especially shale oil in the US) and reduced global demand. The latter could spell trouble for India’s exports. Lately, the country’s trade deficit has been worsening, with export growth lagging far behind that of imports.

A further weakening in exports could exacerbate the situation. The economies of countries such as Russia, Venezuela and Iran, heavily dependent on oil revenue, are under severe pressure due to the rout in crude oil.

The cost of insurance for debt (credit default swaps) issued by Russia and Venezuela has shot up sharply — suggesting a heightened risk of default. These countries, along with other oil producers in the OPEC group such as Saudi Arabia, UAE, Iraq and Nigeria, account for about 18 per cent of India’s exports. A cutback on demand from these countries does not bode well for the trade deficit.

Also, while India imports most of its crude oil, it also exports a large quantity of refined products such as diesel and petrol. These products make up nearly 20 per cent of the country’s exports. Lower export realisations for these products could also worsen the trade deficit. This, in turn, could exert pressure on the rupee, already showing some signs of weakness in recent weeks.

With their budgets stretched, oil producing nations could cut back on their fund flows to other countries including India; this could mean lower FDI and FII flows. The timing could be particularly bad if flows from the US slow down or reverse in the event of a rate hike there.

Finally, the government’s tax revenue from oil and petroleum products is likely to suffer and could eat into the benefits from lower subsidies.

In 2013-14, the petroleum sector contributed ₹305,360 crore in Central and State taxes — far higher than the ₹70,772 crore under-recovery burden borne by the government.

All said, India could still emerge a net winner from lower crude oil prices. But the exuberant expectations of outsized benefits seem to be getting tempered, if the market fall this week is any indication.