Price of crude oil has risen to a record high of $90 per barrel: How will this affect the Indian economy?

At this point, the recent increase in oil prices does not pose a significant risk to India's macroeconomic fundamentals, but a continued rise could have an impact on India's external indicators and economic development.

Read more : Importing Crude oil from Russia could be advantageous to India and the world Economy

Crude oil price increased to highest level of $90 per barrel

After the OPEC coalition extended output curbs by three more months, Brent crude climbed beyond $90 per barrel on September 5, reaching its highest level since November of last year. It is still circling just below that point.

India is the third-largest consumer of crude oil in the world, and more expensive imports might increase the current account deficit and impede the economy. There are nonetheless compensating forces that support the economy.

Current account deficit may get affected adversely

When a country's purchases or imports of goods and services are more than its exports, it has a current account deficit (CAD).

According to Dipanwita Mazumdar, an economist at the Bank of Baroda, the rupee and current account deficit will be affected by India importing more than 80% of its total oil needs. Up to July in the current fiscal year, inbound oil shipments totaled $55 billion, and she predicted that this dependence would persist even as the domestic economy began to recover.

We predict that oil imports will likely rise by $15 billion, or 0.4% of GDP, for every 10% permanent increases in oil prices from a baseline of $80-85 per barrel. According to her, this will result in a greater current account deficit and could put pressure on the currency.

According to Gaura Sen Gupta, India economist at IDFC First Bank, CAD might increase to 1.9% of GDP if crude oil prices average $90 per barrel for the remaining months of FY24 as opposed to the predicted 1.8% if the Indian crude basket averages $85 per barrel.

If crude oil prices maintain their current level of $90 per barrel, Sen Gupta stated, "We see limited upside risk to our estimate." However, she added, there is still a chance that China would announce a significant stimulus, which would boost commodity prices.

Rising crude oil price and Depreciation of Indian Rupee

Sen Gupta predicted that the dollar's strength would continue in the short run thanks to the tenacity of American GDP, which would support higher Treasury yields. According to Sen Gupta, the rise in crude prices will increase depreciation pressures on net oil importers' currencies like the rupee. Because the nation depends significantly on imports, there would be a significant outflow of domestic currency if import costs rose. As a result, greater supply lowers the value of the currency.

Much is dependent on the RBI's intervention in foreign exchange markets, which aims to reduce volatility on both sides (appreciation and depreciation). Until December, she predicted that the dollar-rupee pair would trade in a narrow range between 82 and 84.

Domestic retail pump prices are unlikely to alter significantly when food costs are high if the oil price shock is not prolonged, according to Mazumdar. Government changes to the duties, which may have some financial implications, can close the remaining gap, she said.

Domestic prices of petrol and diesel expected to remain steady

Sen Gupta agreed, stating that despite crude price volatility, dangers to inflation from rising oil costs are unlikely given that local petrol and diesel prices have not gone up since May 2022. Through March 2024, we predict local retail prices for petrol and diesel to stay steady, resulting in an average headline CPI inflation rate of 5.8% in FY24. In the CPI basket, petrol and related items weigh 2.4% of the total.

According to Mazumdar, a 10% increase in petroleum has a direct effect on the CPI of 15 basis points. "Our baseline forecast of 5.5% for CPI in the current financial year may be subject to an upside risk of 25-35 basis points due to the indirect impact of this pass-through."

Sen Gupta projected that the recently announced reduction in price of Rs 200 per LPG cylinder will only slightly ease inflation pressures in September by 20 to 30 basis points. The impact is greater on the WPI basket, though, since crude-related products are weighted at 7.3%. Mazumdar estimates that an increase of 10% from the current level could result in an upside risk of about 100 basis points.

Increased net imports have a negative impact on GDP growth, which is slowed by higher crude oil costs. According to Teresa John, economist at Nirmal Bang Institutional Equities, a persistent increase in oil prices of approximately $10 a barrel tends to reduce GDP growth by about 20 basis points.

Price increase for crude oil due to lower supply rather than higher demand

She added that the present increase in crude oil prices is unlikely to last for very long because it is being caused by supply reductions rather than increasing demand. John doesn't believe that the costlier crude poses a significant risk to India's macroeconomic fundamentals unless it continues for a considerable amount of time.

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