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How falling oil prices impact India's economy

Lower crude price will surely facilitate room to the Reserve Bank of India in adopting growth-centric approach while reviewing monetary policy.

Updated: Jan 20, 2015, 12:59 PM IST

Crude oil prices are now nearly at a 6-year low in the international market. While the global benchmark Brent crude has hit a low of USD 47.22 per barrel, US WTI crude is trading at around USD 45 per barrel.
Oil prices have already plummeted 60 percent from their 2014 peak. Back in June 2014, the price of Brent crude was at USD 115 per barrel (June 23, 2014). In the last one year, Brent has weakened by nearly 54.04 percent.
The fall in prices is largely due to an over-supply situation, triggered by rising US shale oil exploration. Currently, US oil output levels are at their highest in almost 30 years. The oil-drilling boom in the United States has increased crude production by over 70 percent since 2008.
Further lower demand from the European countries and China, due to insipid economic growth coupled with a stronger US dollar, have also added to oil woes.
The US dollar index, which measures the greenback against a basket of six major currencies, has gained steadily for months and was last quoted at 92.52, the highest level in 12 years. A stronger US dollar typically dents oil prices as investors who buy crude and other commodities as hedges against inflation start dumping their positions to cut their losses. A rising greenback also makes dollar-denominated commodities more expensive for holders of other currencies, further tempering demand.
OPEC states, the world's largest oil cartel, could support global crude oil prices by cutting back their own production, but there is little sign they want to do this.
World's second-largest crude producer, Saudi Arabia is loudly backing the game of OPEC by deliberately restraining itself from supply cut. The main purpose of this calculated step is to make shale oil exploration uncompetitive in the United States.
For Saudi Arabia's economy, the current level might not be disastrous in the short- term due to its large reserve fund of around USD 750 billion which it will use to finance its deficits. However in the long-term, the country needs oil prices to be at around USD 80 per barrel.
If the prices sustain at their current levels or see more decline then it will be very difficult for the US shale oil producers to continue their operations and Riyadh might hope to increase its market share in the longer run by throttling the US oil boom.
As per experts, shale oil exploration is not competitive below the level of USD 60 per barrel.
As far as India is concerned, falling crude is certainly a blessing for the economy as it helps macro-economic management (both budget and fiscal) by improving macro fundamentals (inflation, fiscal deficit and current account deficit).
India imports more than two- thirds of its requirement, which constitutes around 30 percent of total imports. A fall of one-dollar in the price of oil saves the country about Rs 40 billion. Adding to that the fall in international oil prices will reduce subsidies that help sustain the domestic prices of oil products (LPG, kerosene).
Moreover, lower crude price will surely facilitate room to the Reserve Bank of India in adopting growth-centric approach while reviewing monetary policy. It is estimated that a fall of USD 10 in crude could reduce the Current Account Deficit by roughly 0.5 percent of GDP and the fiscal deficit by around 0.1 percent of GDP.
Investment bank Nomura estimates that the windfall up to a level of USD 40 can potentially boost growth by up to 0.4 percent in the current financial year.
Also, a recent research report says that a 10 percent decline in oil prices could reduce retail inflation (Consumer Price Index-based inflation) by around 0.2 percent and push up the gross domestic product (GDP) growth by 0.3 percent.
But on the flip side, analysts are also highlighting the potential downside risks associated with lower oil prices. It would be wrong to ignore implications of falling oil prices on markets and the way businesses and companies operate.

Many oil projects will face shutdown if black gold retains current levels or slides further, they opine.
Around USD 2 trillion is now involved in oil exploration business and the companies are trying hard to shelve their production cost. It is going to be very tough for the companies to continue production under these circumstances. There will be either production cuts or the company might declare bankruptcy when production becomes unviable for a long period.
Besides oil companies, many countries like Russia and OPEC states, are also relying upon high crude prices, and we should therefore expect to see a surge in economic meltdown, bankruptcies and sovereign defaults.
Russia is one of the world's largest oil producers, and its dramatic interest rate hike to 17 percent in support of its troubled Rouble underscores how heavily its economy depends on energy revenues, with oil and gas accounting for 70 percent of export incomes.
Russia incurs a loss of about USD 2 billion in revenues for every dollar fall in the oil price, and the World Bank has warned that Russia's economy would shrink by at least 0.7 percent in 2015 if oil prices stay low.
Here, it must be noted that India is heavily dependent upon foreign institutional investors (FIIs) and foreign direct investment (FDI) inflows and when bank funding of such a high magnitude and budgets of oil exploring companies go haywire, Indian markets would feel the pinch.
Also, these bankruptcies and sovereign defaults will aggravate the economic slowdown at the global level, which might impact India's exports. A whole range of other issues are also linked with lower oil prices. Servicing of high foreign debt and cash flows of Indian companies might also be a concern.