If the Modi Government acts effectively, the fall in crude prices can bring relief to India. But the dropping prices have also hurt oil-based economies. This can have an adverse impact on the global economy and India, write Sai Shakti and Geethanjali Nataraj
Crude oil, which is an important factor in global geo-politics, is seeing wide swings in the international market. Surprising the world, it has fallen from record highs to record lows. Since June 2014, there has been a staggering 40 per cent drop in oil price — from $115 per barrel to below $50 per barrel. There are two main factors that determine the price of crude oil — first, the basic economic principle of supply and demand, and second, public expectation which can be defined as the amount of oil that can be purchased in the international market at a given point of time.
Demand is also influenced by weather conditions. During winters, the demand of crude oil spikes in the southern hemisphere. Countries that use air conditioners have a significant need during summer. The weakening of economies the world over, an investment drought, the growing efficiency of vehicles and a switch from oil to more sustainable sources of power, have all resulted in a sharp decline in demand.
The Organisation of Petroleum Exporting Countries is no longer the largest producer of crude oil. That title is now held by the US. Though the US does not export the oil it produces, it is not buying oil either. Considering that it was once a major buyer, nine to 10 million barrels per day, it is no great surprise that the price has dropped, as there is a lot more surplus oil available for sale.
Countries like Iraq and Iran, which were pre-occupied with internal conflicts not too long ago, have now become relatively stable to start supplying again. The massive increase in oil prices that had occurred also fuelled large investments in oil exploration and drilling. All these factors have caused a jump in supply but there has been no no reciprocal increase in demand. In fact, there has been a slump in demand, forcing oil prices to go down.
Finally, the Gulf countries and Saudi Arabia have decided not to curb production and sacrifice a chunk of their market, which they could have done to restore the falling price. Perhaps, they have chosen not to act because a restoration in the price of oil would mainly benefit countries that they detest — like Russia and Iran. Saudi Arabia has a $900 billion bank reserve and can easily bear the backlash of lower oil prices.
It remains to be seen if and when the fall in oil prices will stabilise and what the repercussions of that will be for the various economies of the world. Oil is critical to India as this country imports almost two-thirds of its need; this constitutes 37 per cent of its total imports. A one dollar drop in oil prices can save India approximately Rs40 billion.
For India, the drop in oil prices currently looks like a blessing but it can possibly turn sour. On the one hand, lower oil prices can be a much needed boost to the gross domestic product growth, as it will increase the household’s real disposable income, increase money available for policies oriented towards growth, and also substantially add to corporate profit margins due to lower input costs. This might also motivate the corporate sector to invest more in the economy.
It is estimated that if the price of oil falls about four dollars per barrel, it will on an average shrink the trade deficit by three billion dollars. This adds to the fact that India’s current account deficit has already dropped to $7.5 billion, and it should help strengthen the rupee. It is a boon for the Modi Government and the timing could not be more ideal. The Government will be able to mend the balance sheets and fulfil the huge mandate it has promised with relative ease.
This extra money and saving affords the Government of India, the opportunity to keep its fiscal deficit well within the target of 4.1 per cent of the gross domestic product. The drop has also allowed the Government, an opportunity to roll out some much needed fuel subsidy reforms, starting with the scrapping of the diesel subsidy which subsumed 0.3 per cent of the GDP last year. The reduction in international crude oil prices will also soothe the effect of inflation to some extent, but whether it will be strong enough to make any significant impact, remains to be seen.
The 0.25 per cent rate cut recently announced by the Reserve Bank of India, can be perceived as a turning point for the Indian economy. After two years with no signs of relief, the announcement has been hailed as a game changer by both the business community and the common man alike. Though the cut itself is only symbolic and doesn’t hold much financial weightage, it is a definite sign that more good news is on its way. All this may sound exactly like what India needed but there might be a flip side. In 2014, the Oil and Natural Gas Corporation and Oil India limited bought a 10 per cent stake in a Mozambique gas field for two and half billion dollars. Now with the fall in crude oil prices, analysts estimate, that the value of the oilfield will go down by over 25 per cent.
All oil companies will take substantial hits — oil assets take large investments to keep up production and, with the drop in prices, their cash flow is bound to be lower. The rupee is estimated to fall against the dollar to Rs65; this will translate into domestic companies paying much more for foreign loans they might have taken out.
Other possible downsides include the fact that countries with oil-based economies will not be able to invest in India as their own purse strings will need to be tightened. Also the huge population of Indians in the Gulf could be affected if the Arab countries are hit. India seems to be one of the few countries that has largely benefitted by the fall in oil price. But will the Government take effective steps to utilise this bout of good fortune and translate it to real benefits for the common man, is yet to be seen. One can only hope that after a slew of bad times for the Indian economy, the Modi Government will utilise this opportunity to the fullest and the people can reap the benefits of what is definitely a much-needed rain cloud of luck in our otherwise drought-ridden economy.
(The writers are working with the Observer Research Foundation)