Motilal Oswal has come out with its report on oil. According to the research firm, over the years, the Indian economy's capacity to withstand higher oil price has improved. If oil price holds at USD100/bbl in FY13, the stress for the economy in terms of net import and subsidy bill would be similar to that of FY08.
Oil < USD100 is a game changer for India
- Brent crude is below USD100/bbl after a gap of 15 months, down 23% from the recent peak of USD126/bbl.
- The decline in oil price comes as a significant relief to the Indian economy. We estimate that every USD10/bbl decline in oil price would result in the following:
- CAD/GDP would go down by 0.3-0.5%.
- Fiscal deficit would improve by 0.3% of GDP.
- Inflation will fall 40bp (under no pass-through) and 97bp (if there is complete pass-through).
- Oil at USD100 today is equivalent to USD80 in FY08 in terms of the stress it creates for the economy. We believe oil <USD100/bbl is a game changer for India.
Brent crude below USD100/bbl, though intra-sector anomalies persist: Brent crude price has fallen 23% below the peak of USD126/bbl scaled in March 2012. It has declined to below USD100/bbl after a gap of 15 months, driven by concerns on the European economy and overall slowdown in demand. While structural anomalies like (a) price differential between WTI and Brent, and (b) delinking of gas price from oil are likely to continue in the medium term, US efforts to become energy independent could alter the oil markets forever.
Fiscal deficit would decline by 0.3% of GDP under current conditions. The government has the ability to withstand oil price of USD110/bbl only at an exchange rate of INR48/USD, but this improves dramatically to INR60/USD, if oil price comes down to USD90/bbl. The government's subsidy provision for FY13 merely equals its 4QFY12 obligation. Thus, even at oil price of USD100/bbl, there is a risk of fiscal slippage of 0.4% of GDP. At the current exchange rate and domestic product prices, the zero-subsidy breakeven crude price is USD76 for diesel, at USD65 for LPG, and USD25 for kerosene.
Inflation benefit would vary between 40bp (under no pass-through) and 97bp (when there is complete pass-through). Falling oil price gives the government higher flexibility on pass-through pricing, the first step towards deregulation.
Brent crude price below USD100/bbl after 15-month gap
Brent crude price has fallen 23% below the peak of USD126/bbl scaled in March 2012. It has declined to below USD100/bbl after a gap of 15 months, driven by currency movement, the European economic crisis, slowdown in China and moderation in the Iran conflict, among others. Crude oil inventory in the US, a crucial determinant of international oil price, has increased rapidly and is currently at a two-decade high.
CAD/GDP declines by 0.7% with every USD10/bbl decline in oil price
Our calculations indicate that with every USD10/bbl decline in oil price, India's net oil import bill declines by USD10b. This amounts to nearly 0.5% of GDP. Even if the saving is less, accounting for synchronous reduction in oil export proceeds, co-movement of oil price with other commodity prices and lower remittances from Middle Eastern countries, the CAD/GDP ratio would decline by 0.3-0.5% for every USD10/bbl decline in oil price.
Fiscal deficit would decline by 0.3% with every USD10 decline in oil price
Our calculations indicate that with every USD10/bbl decline in oil price, the fiscal deficit would come down by 0.3% of GDP. Exchange rate plays a crucial role in determining the actual amount of under-recovery and subsidy. We present below grids showing the under-recoveries and the government's oil subsidy bill at various levels of oil price and exchange rate. In the exhibits, we have highlighted the government's zone of comfort from a fiscal perspective. We note that even the current levels of oil price and exchange rate would require continued subsidy.
Inflation/inflationary expectations would come down significantly
Another very direct benefit of a decline in oil price is a decline in inflation and inflationary expectations. With every USD10/bbl decline in oil price, inflation would ease by 97bp if the government passes on the entire benefit of the oil price decline to the consumers. If it leaves the regulated prices (diesel, LPG and kerosene) unchanged at current levels, the impact on inflation would be limited to the extent of 40bp.
Oil @ USD100/bbl today equivalent to oil @ USD80/bbl in FY08
Over the years, the Indian economy's capacity to withstand higher oil price has improved. If oil price holds at USD100/bbl in FY13, the stress for the economy in terms of net import and subsidy bill would be similar to that of FY08. Thus, oil at USD100/bbl today is equivalent to oil at USD80/bbl in FY08, in terms of its direct impact.
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