Brent crude oil shot past $85/barrel last week, for various reasons. Donald Trump’s insouciance in forcing a renegotiation of the nuclear deal with Iran, (which all other signatories do not wish to), upon threat of sanctions, has resulted in a reduction of Iranian oil coming to market.
Iran produces 3.9 million barrels a day (mbd). Venezuela, whose main energy company, PDVSA, was raided under the Presidentship of Hugo Chavez, does not now have the resources to extract more oil despite having the world’s largest reserves. Its production of 2 mbd is also falling. Some of the African countries are having political turmoil. Production of shale oil/gas in the US has fallen.
India, which imports 80 per cent of its crude oil, is hit in several ways. Rising crude prices translate into higher prices of petro products; Indian petrol prices are hitting 100 faster than Indian cricketers. The burgenong import bill for crude has weakened India’s currency to lifetime-lows.
This, in turn, means that foreign investors lose out on conversion what they gain in the market’s appreciation. FIIs have been aggressively selling, and if, as is expected, the US Fed raises interest rates yet again, in December, there will be further outflow of FII funds from equity and debt markets. That would further depreciate the rupee.
Litmus test for markets
FII outflows have, thus far, been matched by domestic retail inflows through mutual funds, as Indian savers have discovered that bank deposits, their traditional route of savings, does not protect them against inflation, and gold, another preferred investment option, has not appreciated for years. The litmus test will come when there is a sharp fall in the stock market and the strength of the retail investors’ appetite for stocks will be tested.
Compared to the previous crude oil shocks (crude oil had touched $140/b) the effect on retail prices of petrol/diesel is worse because the currency has also depreciated.
So, investors need to be concerned about both the falling currency and the rising oil prices, and the combined effect on the stock market, which can be immense if the retail investor were to lose his nerve and stop putting incremental savings into mutual funds.
Rising crude oil prices will also translate into higher inflation, to counter which (as well as to counter rising interest rates in the developed world) the RBI can be expected to hike interest rates in the next policy review.
Also, contributing to the weakening rupee is the disdain we, as a nation, show to earning a proper return on capital invested, as evidenced in the 100 PSUs which are continuously losing money but yet maintaining a zombie existence with taxpayer money, because the political class is unable to take on the power of the unions. The polity is fortunate that taxpayers are patient and do not organise themselves into a group. Instead, they blame it on their ‘karma’.
Another factor contributing to a weakening currency is the inefficacy of the judicial system to punish offenders, especially those who are ‘politically connected’.
Singapore’s Lee Kwan Yew gave a free hand to law enforcing authorities as soon as he became PM. Today, the country has one of the highest per cap incomes in the world, 42 times that of India. In 1947, the per capita income of both countries was similar. Think of that!
(The writer is India Head — Finance Asia/Haymarket. The views are personal.)