In sharp slide in global oil prices, hope for easing of inflation in India

In a major relief to the Indian economy, the Brent crude prices have fallen sharply over the last ten days. While they were trading at around $110 per barrel in July end, the prices have declined to under $90 per barrel. The decline has been very sharp over the last ten days as they dropped around 13% to trade at $88 per barrel on Thursday. If on the one hand it is a reflection of expectations of slowdown in global growth which may have its bearing on India’s growth too, on the other it comes as a big respite for India which imports almost 85% of its oil. Softening in crude oil prices can ease-off a part of the inflation.

What led to this?

The crude prices fell sharply by around 4% Wednesday and the decline has come despite OPEC’s announcement to cut supply by 100,000 barrels per day beginning October in a bid to prop up the prices. While the prices have been softening over the last couple of months, the recent sharp decline is due to renewed fears of recession in Europe and decline in demand from China, which brought in new Covid lockdown measures amid weakening factory activity. There is a concern that these factors could dent the future demand of crude oil.

Market participants say OPEC’s decision to cut production is in itself an indication that it expects decline in demand and further softening in prices.

“Crude oil prices slumped to their lowest levels since January on Wednesday, after weak economic prints from China, interest rate hikes and a surprise rise in US inventories brewed concerns over slowing demand. The US energy watchdog forecast slightly higher demand and tighter supply going into 2023. We expect crude oil prices to trade sideways to down with resistance at $84 per barrel with support at $80 per barrel,” said Tapan Patel of HDFC Securities.

What does this mean for India?

India imports nearly 85% of its crude requirement and in the year ended March 2022, the oil import bill doubled to $119 billion on account of rise in prices. The rise in import bill not only leads to inflation and rise in current account deficit and fiscal deficit, but also weakens the rupee against the dollar and hurts stock market sentiment.

A rise in crude oil price also has an indirect impact on India as it leads to a rise in edible oil prices, coal prices and also that of fertiliser as they use gas as the feedstock. Gas accounts for 80% of all fertiliser production costs.

So if a rise in crude oil prices could lead to a much enhanced import burden, it also leads to reduction in demand in the economy which hurts growth. It could also lead to higher fiscal deficit if the government chooses to bear the burden by way of subsidies.

In that sense, a softening in crude oil prices is a big relief for all stakeholders – the government, the consumers and even the corporates. If oil continues to trade at lower levels, it will result in lower inflation levels, higher disposable incomes and thereby higher economic growth.

Will RBI pause on rate hike?

While the inflation has softened from 7.79 in April to 6.71 in July and the trajectory is expected to be downwards going forward in line with the decline in the crude oil prices and other commodities, it is unlikely that RBI would take a pause.

Experts say that while the oil marketing companies (OMCs) have been bearing the burden of high oil prices, it will depend upon whether the government and OMCs take steps to bring down the prices for consumers following the fall in global crude oil prices. “While I think it will bring a breather to the OMCs, I don’t see a decline in retail inflation on account of softening crude oil prices as retail prices of fuel may continue to stay high,” said Madan Sabnavis, chief economist at Bank of Baroda.

If that is the case, the RBI may go for a rate hike in its forthcoming monetary policy meeting. So, one will have to wait for a sustained lower crude oil prices for a longer period of time and for the same to be passed on to retail fuel prices and a meaningful softening in inflation before RBI draws comfort and takes a pause.

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What impact will it have on equity and debt markets?

Over the last four trading sessions the benchmark Sensex at BSE has risen 1.5%. Among other factors, a softening crude oil price has also played a role in the index rise as companies across sectors that are sensitive to crude oil prices have witnessed a rise in their share prices. Market participants also believe that a revival in demand in the economy will lead to earnings revival for companies over the next couple of quarters.

If decline in crude oil prices is positive for the Indian economy and equity markets, investors should invest with a long term focus; debt investors too should now prepare themselves to lock into high interest rates as they peak over the next few months. While 10-year GSec yield is currently trading at around 7.14%, given that the environment continues to remain challenging and RBI could continue to raise rates, the interest rates could rise further.

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