RaboResearch - Economic Research

The downsides of India’s oil addiction

Economic Report

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  • The oil market is going through a rocky period. Since mid-2017, oil prices have risen substantially, which is mainly related to supply-side factors
  • In a recent study, we assessed the impact in two oil price scenarios on different economies in the world. In a mild scenario, oil prices climb to USD 90 per barrel for some quarters. In a severe scenario, prices rise to USD 115 per barrel and remain around that level until 2022
  • With crude oil having a share of 18% of total imports, India is one of the most vulnerable emerging markets in case of rising oil prices
  • In anticipation of the general elections in India next year, a continuing increase of oil prices could become a real liability for Modi and his BJP

The oil market in turmoil

Figure 1: OPEC+ deal did not bring any relief
Figure 1: OPEC+ deal did not bring any reliefSource: Macrobond, Rabobank

The oil market is going through a rocky period. Since mid-2017, oil prices have risen substantially (figure 1). Many hoped that the OPEC+ meeting on 22 June would take off some of the pressure on oil prices, but the deal resulted in an underwhelming production increase of 600,000 to 700,000 barrels per day. Moreover, the US State Department said that it wants buyers of Iranian oil to cease purchases from November onwards. As Iran is responsible for 5% of global oil production, the market is expected to remain tight and we could see prices pick up in the near future again. The Norwegian Minister of Petroleum and Energy Terje Søviknes even said that it is far from unlikely that we will see prices go up to $100 again (see Bloomberg), as the market still faces the impact of drastic oil investment cuts from the last three years.

The economic impact of rising oil prices

Recently, we assessed the economic impact of an upward oil price shock for countries across the globe. In a mild scenario, oil prices would climb to USD 90 per barrel for some quarters and then would level off, as the US dampens the supply shock by firing up the engine on shale drilling. In a severe scenario, prices rise to USD 110/115 per barrel and remain around that level until 2022 due to severe supply constraints. Ultimately, however, the high oil price will attract substantial capex spending investment, which will result in enhanced capacity, albeit with a substantial delay of several years.

For the global economy, rising oil prices can be interpreted as a cost-enhancing form of monetary tightening, which is happening in tandem with a drain of global US dollar liquidity on the back of Fed tightening – a combination of gradual rate increases and a wind down of the Fed’s asset portfolio. Our results indeed show that global growth will slow in these scenarios by 0.4ppts-0.9ppts between 2018-2022. The economic impact of an oil price shock is, however, very unevenly distributed between countries. We can roughly distinguish three different groups: the lucky ones, the uncomfortable ones, and the vulnerable ones: see figure 2.

The lucky ones are net oil exporting countries that benefit from a rise in oil prices, e.g. the Middle East and Russia. Russia would experience a goldilocks trajectory in especially the severe scenario, combining relative low inflation below 5% with very high economic gains (6.8% in 2019). The uncomfortable ones are net oil importing countries that would face moderate losses, for example the US and Eurozone. The vulnerable ones are the net oil importing emerging economies, such as India, Turkey, Vietnam and South Africa. In the case of a fast rise in oil prices, these countries would experience a relatively heavy depreciation of their currency, a swift rise in investment premiums, a spike in inflation and a substantial blow to the economy in the short term.

Figure 2: Winners and losers in case of an oil price shock
Figure 2: Winners and losers in case of an oil price shockSource: Rabobank

Impact on India

With crude oil having a share of 18% of total imports, India is one of the most vulnerable emerging markets in case of rising oil prices. First of all, the high oil price of currently around 75 USD is already pulling the current account (CA) deficit lower (figure 3). We expect the CA deficit to deteriorate to -2.6% of GDP this fiscal year (FY2019) before recovering to -1.7% next fiscal year (FY2020). But if the oil price gets pushed higher to 85 or 90 USD, we could be looking at deficits of -2.8% (FY2019) and -2.4% (FY2020). In our severe scenario, the deficit would end up being -3.3% in both fiscal years. Large and persistent current account deficits do not bode well for portfolio investment and the INR (see Bloomberg). These risks are exacerbated by the general risk-off sentiment among investors and a general squeeze of US dollar liquidity. Indeed, we also find that the INR could depreciate by as much as 8% in our mild oil scenario and 12% in our severe scenario, which would raise import prices to even more elevated levels.

Although India’s external sector would benefit from a weakening currency, which would raise the cumulative growth contribution of net trade by 0.5ppts (mild) and 0.7ppts (severe) until 2020, these benefits are far too small to make up for the negative domestic dynamics. Domestic private consumption and business investment would take a hit and ultimately, the Indian economy would end up being worse off by 1.2ppts (mild) and 2.3ppts (severe) up to 2020 compared to our baseline scenario (figure 4). 

Figure 3: Current account deficit deteriorates
Figure 3: Current account deficit deterioratesSource: OECD, IMF, Rabobank, Macrobond
Figure 4: In a severe oil scenario India could lose out on 2.3ppts of growth in the short term
Figure 4: In a severe oil scenario India could lose out on 2.3ppts of growth in the short termSource: Macrobond, NiGEM, Rabobank

This is equal to INR 433bn and INR 860bn of missed ‘economic activity’, respectively. The Indian economy would make up for some of these losses after 2020, but ultimately the long-term damage would still end up being in the range of INR 300bn-500bn (USD 5 to 8bn). Such an impact would certainly bring back memories of the demonetisation impact of last year.

India’s energy transition

In anticipation of the general elections in India next year, a continuing increase of oil prices could become a real liability for Modi and his BJP. Keep in mind that the Arab Spring was not caused by people embracing a more democratic regime (although in the West we really want to believe that), but by surging oil (and food) prices absorbing an ever increasing share of real disposable income of people in developing and emerging economies. India faces that risk too. And although India has been focusing on increasing investment in renewable energy, this is still a drop in the ocean. One wonders whether speeding up the energy transition in order to secure energy supply and make India less dependent on external volatile fluctuations could be Modi’s game changer in securing the BJP’s election victory.

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Author(s)
Hugo Erken
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 52308

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