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Crude oil prices have always been a major factor impacting the Indian economy, as around 75 per cent of India’s crude oil requirements are met through imports. They form a major chunk of the entire import bill, which amounted to $150 billion in the financial year 2013-14. As the Indian economy has grown, along with rising energy requirements, the prices of crude have created considerable pressure on foreign exchange reserves and the amount of subsidy being provided by the government.
The recent rapid and steep fall in international crude oil prices has changed the dynamics of crude oil imports.
The price of any asset or commodity depends on the demand and supply mechanism in a market economy. In the case of crude oil in the past decade, the demand side generated another major participant and competitor with the United States for crude oil supplies; i.e. China. The huge demand for crude oil from China kept the oil prices in the higher range, over $100/- per barrel, combined with the artificial low supply by OPEC countries and conflicts in various oil producing countries. This pushed the oil prices upwards till they reached almost $130/ barrel in 2012/13.
As has been evident at different times, a monopoly cannot be sustained. High oil prices instigated countries like US and Canada to enhance oil exploration efforts and extract oil from the shale formations within their countries. As a result now, there were sources available, other than OPEC countries, which could satiate the oil hunger of US.
The demand created by the United States of around 9-10 million barrels per day was met by its own shale oil production. The international supply of crude oil also increased due to the re-emergence of new players like Iraq in the oil production arena.
Excess supply, including OPEC’s decision to not cut crude production in November 2014 led to depressing oil prices. Crude oil is still sliding because of a glut in the market, and continues to slide due to the commodity market being bearish about crude oil in the future and financial positions are deleveraged in crude.
Oil at $50-55 would lead to losses for many shale oil producers in the US. This would make the leveraged players highly unstable, and can be a potential reason for stoppage of further exploration. Moreover, conflicts in the Middle East cannot be ruled out, which can, in turn, further lead to a shortfall in supply. Hence, there is a chance of crude oil prices rising again to a moderate level in the near future.
Decrement in oil prices is bad news for the world economy as a whole because the multiplier effect created by the oil producing countries is much higher than the gains from the cost saving to the oil consuming economies. Countries in turmoil like Russia and Venezuela would face added pressures due to the low prices, and countries like Saudi Arabia would have to let go some of the foreign exchange reserves they have earned over the years. On the other hand, oil consumers like US, China, Japan and India would be largely benefited out of the current slump in crude oil prices.
India is the fourth largest consumer of crude oil in the world. A dip in crude oil prices would lead to huge savings of foreign exchange reserves and lowering the import bill. It has been estimated that a $10 fall in crude oil prices would lead to reduction in the current account deficit by 0.5% of GDP and reduction in fiscal deficit by 0.1% of GDP.
This also fuels the lower inflation expectations and helps the much-awaited rate cut by RBI. However, there are negative effects attached to the dip in oil prices for India too. First of all, exports from India to oil producing countries could get hampered due to their low growth. Also, a huge Indian diaspora works in the oil producing countries, particularly in West Asia and the Gulf. A slump in the growth of these economies would also have a negative impact on the amount of inward remittances for India. Hence, a large dip in the crude oil prices isn’t always good news for the oil consuming countries.
Specific sectors which would be benefited from low crude oil prices would be automobiles, plastic industries, chemicals, paints and footwear manufacturers. There is also a positive side for government because the enormous subsidy burden has decreased.
However, the negative impact would be felt by the upstream oil and gas companies. Private sector oil companies have suffered since they get order flows from the oil and gas sector which is in a slump due to the slump in crude oil prices.
The current volatile environment in the crude oil price arena has had a contagion effect on all the countries. India has not been an exception. However, India has better prospects once the falling crude oil prices stabilize because capital inflows would be directed towards India, with investors looking at falling iron ore prices weakening Brazil and Russia in turmoil due to falling crude oil prices. China can be a potential competitor for India, but, with a dynamic government in place for India, enacting productive widespread reforms, India should stand to gain from this sudden crisis in the world economy.
Omkar Raut is a Graduate Student with the Symbiosis School of Economics.