Falling oil prices – effect on India , demystified pointwise

Oil prices have been falling for a while, and they are likely to remain low. The conventional thinking is that a fall in oil prices will benefit India tremendously. A major reason for the same is that India imports nearly four fifths of the oil that it consumes.

Will India only benefit or is there a flip-side to this coin? Read further to find out.

How does India benefit?

▲ The oil bill forms a major chunk of imports. It will reduce.

▲ As a result of less amount paid for import, Current Account Deficit will be under control. This will also give room to the government to unwind gold import curbs.

▲ Low oil prices will also mean lower inflation and a lower fiscal deficit for the government.

▲ Interest rates are most likely to fall. Lower oil prices might just push Rajan to alter the policy rates.

So, how good are low oil prices? If this free fall continues, it can backfire and restrict  growth. Let me explain this in detail.

Disadvanatges ?

▼Collapsing oil prices signal a weak global demand. This low global demand can also translate into lower demand for Indian exports.

▼ Weak oil prices will hit revenue of ONGC and Oil India. Refining companies might report huge inventory losses. The sharp decline in crude oil price will imply loss of tax revenue and dividend payouts by oil PSU companies, which together will outweigh reduction in oil subsidy.

▼ Stronger dollar is generally accompanied by a weakening in crude, other commodity prices and emerging market currencies. This would mean a fall in the rupee against the dollar, which would have a negative impact on WPI inflation.

▼ If oil exporting countries earn lower, their sovereign wealth funds will invest a lower amount of money in India. Capital Flows will get impacted.  Norway, Abu Dhabi and Saudi Arabia run the three biggest sovereign wealth funds in the world.

▼ Empirical data shows that the correlation between crude price and India’s GDP growth and corporate earnings is not negative but positive. This implies that India’s GDP and profits rise when crude prices rise and fall when the prices decline. Also, Every 10% decline in global commodity prices results in 600 bps decline in gross tax collection. The government in fact announced a 10% cut in non-plan expenditure, thereby compromising on growth. This explains why GDP growth declines with lower commodity prices.

So, as I mentioned, there is a flip-side to this oil price fall. A free fall is not good. And it can have a potential impact on the economy. As far as this current scenario of oil price fall is concerned, it certainly is indicative of the loosening grip of oil over the global economy. It will also bolster investments in renewable energy sector, gradually.