How falling crude prices impact India's GDP, inflation

Led by hopes of an increase in supply thanks to the US shale boom as well as prospects of weakness in the global economy, international crude oil prices have been on the decline over the past several months. Led by hopes of an increase in supply thanks to the US shale boom as well as prospects of weakness in the global economy, international crude oil prices have been on the decline over the past several months.

In September, the cost for the average crude barrel imported into India came down below USD 100 for the first time since July 2012, data from the Petroleum Planning and Analysis Cell shows (see chart below). Weakness in crude price augurs well for India, which imports about 70 percent of its petroleum requirement, and results “in lower inflation, improvement in fiscal and current account balances and higher growth,” a recent note by brokerage firm Nomura said.

Here’s how.

GDP growth: Lower oil prices should boost growth through multiple channels: (1) lower inflation will boost households real disposable incomes, thereby pushing higher consumer discretionary demand; (2) improved corporate profit margins due to falling input costs will be an additional tailwind to reviving business investment; and, (3) improvement in macro fundamentals (inflation and the twin fiscal and current account deficits) will, at the margin, increase the space for macro (monetary and fiscal) policies to boost growth. 

Every USD 10 per barrel fall in oil price can boost GDP growth by around 0.1 percentage points, according to Nomura.

Inflation: Given the higher share of tradable goods in the wholesale price index, the impact of lower commodity prices is much higher on WPI inflation than CPI inflation. Lower oil price directly impacts 8.6 percent of the WPI basket (crude petroleum and fuels excluding kerosene and LPG) and, additionally, around 5 percent indirectly through lower price of crude derivatives such as chemicals. 

Every USD 10 per barrel fall in crude oil price lowers WPI by around 0.5 percent and CPI by about 0.2 percent. 

Current account balance: Every USD10 per barrel fall in crude oil price improves India’s annual current account balance by around USD 9 billion or 0.5 percent of GDP. 

Fiscal balance: Petrol pricing is already market determined and oil marketing companies (OMC) are currently generating over-recoveries (profits) on diesel. 

Nomura's oil & gas analysts believe that benefits of over-recoveries on diesel may not stay with OMCs as these would be offset against diesel under-recoveries earlier in FY15. While this may not improve the OMCs profitability, this will reduce the government's fuel subsidy burden in FY15. The diesel subsidy, which amounted to 0.3 percent of GDP in FY14, will be eliminated going forward. 

“Overall, lower commodity prices further support our view that India is entering a goldilocks period of lower inflation and higher growth,” analysts at Nomura wrote, adding that they expect India’s GDP to rise to 6 percent in FY15 from 4.7 percent in the last financial year.

“On the inflation front, we expect CPI inflation to undershoot the RBI’s target of 8.0 percent by January 2015 and to meet the 6 percent target by January 2016.”

Source: Money Control