If crude reaches $100, how will the world and Indian economy react?

If one were to look at the price of Brent Crude in the last 1 year, the volatility has been so huge that virtually anything is possible.

May 03, 2019 03:05 IST India Infoline News Service

The debate over sharply higher prices of crude oil is nothing new. Back in the mid-2000s when Goldman Sachs first spoke about $200/bbl on crude, most analysts dismissed the thought. By early 2008, crude had gotten close to $150/bbl and had it not been for the Lehman crisis it would have probably scaled $200/bbl. We will never know! In the last few months, despite the vagaries of oil prices, the debate over $100/bbl is back in the limelight. What would $100/bbl of oil mean?
 
Obviously, it will mean a big shift in wealth from the oil consuming countries like India, Japan, China and EU to the oil producing nations of the Middle East, Africa and Russia. But the effects of crude at $100/bbl will be a lot starker. Here is how.
 
What $100/bbl of Brent means for the global economy?
Crude oil price chart
Chart Source: Bloomberg
  • If one were to look at the price of Brent Crude in the last 1 year, the volatility has been so huge that virtually anything is possible. With hedge fund veering towards steeper oil prices, what would $100/bbl of oil mean for the world economy?
  • The first casualty could be global GDP growth. Higher oil prices will mean a direct hit on consumption and spending. The impact of $100/bbl of crude oil could compress global growth by at least 50-60bps according to Oxford Economics estimates.
  • The second impact would be on global inflation. Oil at $100/bbl will mean a sharp rise in consumer inflation. Here again Oxford Economics estimates that the impact on global inflation would be anywhere between 70bps and 100bps. That could mean lower real returns on debt leading to a hawkish monetary policy by central banks.
  • According to Nomura, oil at $100/bbl could help a lot of oil producers improve their macros. For example, Saudi Arabia needs $70/bbl to balance its budget and $100 would be a huge bonus. Other gainers will be Russia, Norway and Nigeria.
  • Here again Nomura is of the view that the big losers if oil touches $100/bbl would be the vulnerable economies with a relatively higher level of fiscal and current account deficit. Nomura has identified Turkey, Ukraine and India as the most vulnerable to an oil shock.
 
What does $100/bbl oil mean for Indian economy?
  • India relies on oil imports for ~75% of its daily oil requirements. India’s macro challenges normally start when oil crosses $70/bbl. We are talking about a price that is nearly 50% higher than the problem price.
  • The biggest challenge will be to manage the domestic prices of petrol and diesel. With revenues under pressure, cuts in excise duty are ruled out. The choice is between passing on hikes and parking it in OMCs. Both are equally bad choices.
  • For the RBI it creates a real dilemma on the monetary front. For example, oil at $100/bbl is surely going to be inflationary with inflation likely to breach the RBI’s upper limit of 6%. The dilemma is should the RBI hike rates or keep rates low to spur growth?
  • The current account deficit is another challenge for India. It is estimated that every $10 increase in crude prices widens the current account deficit by nearly 0.50%. With the CAD already at 2% of GDP, the room for error is quite small.
  • The rupee could be the big casualty as we saw in October 2018. Crude at $100/bbl would mean a wider trade deficit, higher CAD and pressure on the external ratings of India’s sovereign debt. That means the rupee will be clearly under pressure.
 
Finally, what will be the impact on equity markets? In the past, markets have not really reacted negatively to higher crude prices as a lot of heavyweights benefit from better crude realizations. However, mid caps and small caps could take a bigger hit on higher crude and a weaker rupee. That is the space to watch out for!

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