Oil war triggered by Saudi: Boon to Indian Economy

13 Apr 2020  Read 3034 Views

Even as nations around the world are busy battling COVID-19, Saudi Arabia launched an all-out oil war with the biggest cut in its prices in the last 20 years after a failure by OPEC+ to clinch a deal to cut production, owing to Russia's opposition. As a result, oil prices saw a plunge in global markets. Saudi Aramco took immediate action to cut prices after the OPEC+ collapse, offering big discounts for crude deliveries from next month, when the current output restrictions end. 

Across the world nations have gone into a coronavirus lockdown, with flights all over the world canceled as airlines ground their planes, hitting economic activity and fuel demand. That has led to excess supply flooding the market as well. The overnight collapse of oil prices by 25 percent after Saudi Arabia shocked the market by launching a price war against its earlier ally Russia. However, the unprecedented phenomenon could, indeed, be a blessing in disguise for India. The price war that’s currently responsible for the ongoing global stock market crash, gives a lot of hope for the Indian government, which has recently witnessed its fiscal deficit widening due to the low economic activity and a further delay in the disinvestment plan.

 In addition to the crude oil imports, the Indian oil companies in the last couple of years have started importing oil from the US, however, the quantity remains minuscule and forms just about 1 percent of its total oil imports. The Indian oil companies however do not prefer shale gas as it is more expensive for Indian refineries to process it, effectively increasing the price of the output.

India is all set to take advantage of this current situation and snap up millions of barrels of Middle East crude for its strategic reserves. This a positive signal to show its support for global efforts to rescue the energy market. The Indian government and the Finance Ministry are in the process of sanctioning funds so that the state-run refiners can buy the crude upfront from Saudi Arabia, the U.A.E. and Iraq which will be reimbursed later. The country currently has space for an additional 15 million barrels of crude across its three strategic reserves at Mangalore, Padur and Visakhapatnam. As per the plan some officials have revealed that India is seeking to buy from UAEs Upper Zakum around 5.5 million barrels for it’s Mangalore refinery and about 9.2 million barrels of Saudi oil for the Padur caverns. The Visakhapatnam refinery plans to source it from Iraq’s Basrah Light grade. 

The crude oil slump will offset the COVID 19 economic loss

India imports 85 percent of its oil requirement resulting is one of the significant gainers from the oil prices slump. The low oil prices could translate to a lower oil import bill and easing of the current account deficit and inflation. While the rupee will come under pressure, our overall oil import bill should see a fall. 

 Let us study each of these reasons in a little detail.

  • A shrink in the Current Account Deficit:
    India is one of the largest importers of oil in the world imports nearly 85% of its total oil needs, accounting for one-third of its total imports. For this reason, the price of oil has a direct bearing on the value of its imports. Every dollar per barrel reduction in crude oil prices will plummet  India’s import bill by ₹10,700 crores on an annualized basis. A significant price change in crude oil has a direct effect on India's current account deficit (CAD)

  • Correlation of Inflation and oil prices:
    Oil price affects the entire gamut of the economy as it has a contributing factor to all sectors. A rise in oil price spurs an increase in petrol and diesel and leads to an immediate increase in the prices of all goods and services. As a result, inflation rises. A steep inflation rate of 6.58% is bad for an economy. A rise in input costs and results indirectly with a fall in consumer demand. This is why the fall in global crude prices benefits India. Studies have revealed that for every $10 per barrel fall in crude oil price helps reduce retail inflation by 0.2% and wholesale price inflation by 0.5%.

  • Rupee exchange rate:
    The rupee is currently trading at a 17-month low of 74.17 against the dollar. This will also have an inversely proportional effect on the Indian stock markets. Indian equity markets have always fared well in the past, whenever there was a crash in crude oil prices. Currently, Indian markets are reeling under the twin pressures of coronavirus and Banking sector scam. A fall in oil prices is good for the rupee to stabilize. However, the downside is that the dollar also strengthens each time there is a drop in oil prices. This negates any benefits from a fall in the current account deficit.

  • Revenue of State and Central Government - Lower oil prices will also have a direct impact on state and Central governments' revenue figures. If the governments maintain the current levels of oil prices, it will help to shore up revenue. Both Centre and state governments earn a cut from petrol and diesel retail prices. Also, if they pass on the cost benefits to consumers, it will directly translate to more money in people's hands. This will, indeed, improve consumption that has been low over the last few quarters. 

 

The fall in global prices however did not reflect changes to the retail petrol and diesel prices in India which remained on freeze as oil companies utilized it to set off these earnings against the excise duty hike announced by the government. 

All these impacting factors on the economy will fall in place once the lockdown is lifted and industry bounces back to normalcy. India's economy had just begun to witness slight uptick after months of a slowdown in February which fell again post the lockdown when coronavirus started threatening worldwide economic activities. However, if oil prices remain low over an extended period, it will help the Indian economy offset the coronavirus hit it has taken. Once life gets back to normal post the corona control we would see lower crude prices will directly benefit automobiles, aviation, cement, consumer companies, city gas companies, oil marketing companies and paints. However, analysts say the link to the coronavirus outbreak makes the current situation unique. The rapid spread of coronavirus has severely affected the global economy. In the face of an economic slowdown, global oil demand has remained very weak over the past few weeks. 

Typically, a fall in crude prices is good for the Indian economy as it favors the trade balance and aids economic growth, but the current decline is on the back of fear of a global slowdown that is wrecking equity markets across the world. The fall in crude prices was mirrored in global equities too, as the common factor was a global slowdown. While lower oil prices will translate to lower retail prices, this advantage will not be fully realized as the lower oil burden on consumers will likely not fully translate into higher spending immediately as it is occurring against a backdrop of overall a coronavirus lockdown, a downdraft in the economy and financial market volatility. The fall in oil prices comes at a time when the global economy is already reeling under the impact of coronavirus, which has dented demand across sectors and economies. 

About the Author: Bernadine | 31 Post(s)

An MBA Finance graduate, having worked in the Telecom and Banking sector as a Risk and Compliance Manager. An avid blogger with a penchant for traveling

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