It's a mug's game to predict the direction of crude oil prices and the outcome of the general elections, but they matter the most for the Indian economy in 2019
The year 2018 gave us a rude reminder of how important low crude oil prices are to the health of the Indian economy. Putting it crudely, when crude prices fall, we get a boost to growth; when they rise, the current account deficit widens, the rupee falls, prices rise, growth falters and foreign investors desert our shores like rats fleeing from a sinking ship. The high price of crude was an important reason why the UPA-II government wobbled in its final years and it was a big reason why the economy did so well under the current government in 2014-15 and 2015-16. The IMF has estimated windfall gains for India from the fall in crude oil prices were a cumulative 4 percent of GDP in 2015 and 2016.
The elephant in the room for the Indian economy in 2019 therefore is: what will be the level of crude oil prices? To gauge that, we can look at projections by the International Energy Agency, the International Monetary Fund and other usual suspects, but none of them predicted either the spike in oil prices in 2018 or its precipitous collapse. Demand for oil will depend on the state of the global economy, about which there is currently a pall of gloom. The supply of oil will depend on OPEC+ Russia and on output from US shale oil producers.
But while predicting the price of oil is a lot like reading sheep’s entrails, can we at least predict its direction? As far as demand goes, there is little doubt the US growth cycle is getting long in the tooth. Commenting on the US Flash PMI (Purchasing Managers’ Index) data for December, Chris Williamson, chief economist at IHSMarkit said, ‘although growth remains relatively robust, momentum is being lost and is likely to continue to fade as we move into 2019’. The Eurozone Composite Flash PMI for December came in at a four-year low. Chinese growth too is slowing and industrial profits there have dropped for the first time in three years.
But while global demand is coming off, the key question is will it slow as much as the current bearish sentiment believes it will? Currently, the market is pricing in a 64 percent probability of the US policy rate in January 2020 being at the same level as it is today, with about a 26 percent probability of a rate cut. The US Fed, on the other hand, is still pencilling in two rate hikes in 2019, apart from continuing with its balance sheet contraction, which means it believes there’s little threat to growth. So who is right about US growth and consequently US interest rate hikes -- the US central bank or the markets? The IMF and the OECD have lowered their growth forecasts for 2019, but it’s not a huge cut.
What one can say for sure is that if it comes to the crunch, the US and European central banks will once again pull out all the stops to support their economies, as will the Chinese authorities. But here too, everything depends on whether there is an escalation of the trade wars, which could put a lid on Chinese as well as global growth. And of course there’s the political economy of oil, which will depend on how the rivalry between Saudi Arabia and Iran plays out. Needless to add, President Trump is not merely another ordinary elephant in the room, he’s more of a woolly mammoth really.
What about the supply side? As 2018 demonstrated, there are limits to how high oil prices will go, now that the US has become a big producer. The lower limit is when US shale oil producers start to lose money. All we can say is that assuming the growth scenario turns out to be not as bad as the market currently thinks, oil prices could then settle in a band a bit above their current levels.
That should be good for the Indian economy and for the rupee. The IMF has predicted that, taking prices in August 2018, the average drag on GDP from higher oil prices will be 0.64 percent in 2018 and 2019. Brent crude prices are now much lower than they were in August, which means the headwind could very well turn into a tailwind.
That tailwind should be supported by a rise in domestic consumption as the farm loan waivers alleviate rural distress and on account of election spending in the first half of the year. To be sure, there’ll be a price to pay, but that payback will happen only later, long after the elections are over. Loan growth too has picked up and banks are in better shape. That should aid growth as interest rates come down or at the very least stabilise. There are signals that the investment cycle has turned, although the elections need to get out of the way before capex really takes off.
Which brings us to the other elephant in the room---the elections and whether it will lead to an unstable coalition. Optimists point to the 2004 polls, which brought UPA-I to power supported by the communists and yet the economy did well. But the global environment was very different then. It is also undeniable that the present government has tried to create the base for a more robust capitalism in India and its continuation in power will be the best option for business.
At the same time, it is unlikely that a new government will reverse any of the economic reforms and policies of the present one. Despite the rhetoric, when it comes to brass tacks there have been many similarities in the economic policies of the Congress and the BJP. And finally, anticipating the results of the general elections is only slightly less difficult than predicting the price of oil.
It’s entirely possible therefore that the elephants of 2019 could actually turn out to be mice.