Global Slump in Crude Oil Prices Bodes Well for Indian Economy

Global Slump in Crude Oil Prices Bodes Well for Indian Economy

Since August, oil prices in India have seen six consecutive declines as a result of falling international oil prices. The prices of diesel have also been slashed twice in the last month. On the whole, there has been a reduction of around Rs 8-9 per litre for petrol and of Rs 6 per litre for diesel. The last price cut was of Rs 2.41 per litre for petrol and of Rs 2.25 per litre for diesel on Nov 1, 2014. There were speculations of further price cuts being announced by oil marketing companies Indian Oil Corp (IOC), Bharat Petroleum Corp (BPCL) and Hindustan Petroleum Corp (HPCL) on Nov 14 in view of falling crude prices.

However, ending these speculations, on Nov 13 a hike in excise duty on petrol and diesel prices of Rs 1.50 per litre was announced by the government. This means that an excise duty of Rs 2.70 would be levied on unbranded petrol as opposed to Rs 1.70 earlier and for branded petrol it is increased from Rs 2.35 to Rs 3.85 per litre. Apparently, this hike would not be transferred to the consumers and is expected to accumulate additional revenues of upto Rs 14,000 crore for the exchequer which would help meet the fiscal deficit target of 4.1 percent of GDP.

After this announcement, shares of Oil Marketing Companies (OMCs) in India IOC, BPCL and HPCL sank and closed at 4-6 percent lower at the end of trading day. Interestingly, the excise hike came on the same day when global crude oil prices fell about 3 percent to touch new four-year-lows, resulting in a decline in Indian basket crude oil prices as well. It is to be noted that global crudes have tumbled down by at least 30 percent after touching a high of $115 per barrel on fears of oil shortage in June this year.

Apparently, the fall in prices is escalating due to an oversupply of crude oil since, due to increased oil production by US, Iran, Iraq and Libya. It must be understood that OPEC (Organization of the Petroleum Exporting Countries) which comprises of 12 member nations, is responsible for nearly 40% of total global oil production and if it does not cut oil production the prices are set to fall even further and currently most of the OPEC countries including Saudi Arabia, the leading contributor in the OPEC group, are not ready to reduce their oil production in a bid to maintain their global oil monopoly in the long-term.

There are a number of ways that recent fall in global and domestic oil prices can benefit Indian economy some of which are discussed below:

  1. India imports nearly 70% of its petroleum and hence a decline in global oil prices would help lower inflation levels and improve fiscal and current account balances apart from inducing higher economic growth.
  2. In turn, lowered levels of inflation would help add to the real disposable household income and thus push up the demand for consumer goods.
  3. Corporates can benefit from lowered input costs resulting in higher profit margins.
  4. It can also help improve macroeconomic fundamentals and bring down current account deficit (CAD) due to lowered import bills.
  5. With oil subsidies for the current FY 2014-15 running into Rs 63,500 crore, the continuing fall in global prices would also help reduce the oil subsidy burden substantially. This would in turn make it easier for the government to completely deregulate diesel prices.

It must be understood that fuel prices in India are determined by four major factors in different proportion, including raw crude oil prices (with an impact of 55%), cost of oil refining (another 6%), taxations including VAT, excise and cess (another 30-32%) and costs added due to transportation and other related costs (accounting for 6-9%). Of these four components, government would retain control of only the taxations it might levy on oil and petroleum products if it implements deregulation of petrol and diesel prices properly and other factors would remain market linked.

The current fall in global oil prices augurs well for an economy like India which imports most of its oil requirements and deregulation would work well for the time being along with helping the new administration in tackling inflation and fiscal deficit better. However, when the price trend is reversed in global markets it is then that it might present a real challenge for the administration to follow the policy of deregulation without drawing public ire for the same.