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Posted by: Deepa Vasudevan on Thu, Apr 26th, 2018

Why Rising Crude Oil Prices are a Worry

The sharp rise in the international price of Brent Crude from $55/bbl in January to over $73/bbl in April2018 has set off alarm bells. That is because India imports over 80% of its crude requirements. Our oil import bill goes up with every increase in crude prices, but there is no matching increase in exports[1]. In other words, rising crude prices increase India’s dollar payments to the rest of the world, without a similar rise in dollar revenues.

Markets track this by using a metric called the Current Account Deficit (CAD). The Current account deficit is the net amount owed by India to the rest of world due to export and import of goods and services[2].India exports more services than it imports, so it runs a surplus on services. On the other hand, it imports more goods than it exports, so it has a deficit on goods. Taking both goods and services together, there is a deficit on the current account. To understand the role of crude oil prices on CAD, we analyse it in terms of what comes in as inflows and what goes out as outflows (Table 1).

Table 1: What adds to CAD, what subtracts from it

Table 1: What adds to CAD, what subtracts from it

 

This picture shows CAD sliced up in terms of inflows and outflows[3].

Pic 1: Slicing Up the CAD

Pic 1: Slicing Up the CAD

Sources: RBI, Ministry of Commerce, World Bank

In recent years, CAD has been driven mainly by oil imports, which in turn depends on oil prices. A surge in crude oil prices, such as the over-$100/bbl levels seen in 2011-12 and 2012-13, widens the current account deficit, pushes up prices and interest rates, and leads to a loss of confidence in the currency. A period of low oil prices (2014-15 and 2015-16) narrows the deficit, reduces inflation and increases investor confidence.  Effectively, crude prices in India have become a key determinant of country’s macro stability.It is estimated that a $10/bbl rise in crude price leads to a $9-$10 billion increase in the current account deficit[4].

Unfortunately, dollar inflows do not show the same dynamic change. Goods exports have remained stagnant around $300 billion since 2011-12. The surplus on services has grown slowly but erratically. Remittances from overseas Indians and other transfers usually range between $60-$65 billion.

Thus, India is in a situation where inflows from trade are stagnant or growing very slowly, whereas outflows increase considerably when crude prices go up.  The only sustainable way to manage this risk is to create a buffer of strong and growing exports, so that the inflows side of the current account can be strengthened. Until then, our deficit will always be buffeted by crude price cycles.

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[1] In 2016-17, oil imports (Crude + petroleum products) amounted to $80.8 billion, while exports were $29 billion. Source: Snapshot of India’s oil and gas data, March 2018, PPAC

[2] CAD = Imports of goods and services – Exports of goods and services

[3] Some data for 2017-18 is estimated as actual figures are available only until February 2018.

[4] Source: The Economic Survey of India 2017-18

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