Oiling the machinery

Updated: Jun 30 2012, 08:20am hrs
With the crude price of the Indian basket dropping to $97.24 a barrel now, from $123.61 a barrel in March this year, under-recoveries of state oil companies are likely to reduce. But the dampener has been the rupee, which has seen a steep fall against the dollar during the period. State-run oil companies on Thursday cut petrol prices by R2.46 a litre, the second reduction in June.

However, the decline in oil prices comes as a significant relief to the economy. With every $10 a barrel drop in crude prices, the current account deficit as a percentage of gross domestic product (GDP) comes down by 0.5% and the fiscal deficit improves by 0.3% of GDP. This would also bring down the headline inflation, as Morgan Stanley estimates that every $10/bbl decrease in crude prices will bring down the wholesale price index by 90 basis points. Lower oil prices would augment corporate profits. Oil, financial and automobile companies would be the direct beneficiaries. Moreover, if headline inflation starts trending down, it will give the Reserve Bank of India headroom for monetary easing, which could revive investments.

India is highly dependent on imported crude as it imports over 80% of its domestic oil requirement. The exchange rate plays a crucial role in determining the actual amount of under-recovery and subsidy. The subsidy burden can be reduced if oil sector reforms like decontrolling diesel prices are taken forward. In fact, falling oil prices give the government higher flexibility on pass-through pricing, the first step towards deregulation. States, too, can rationalise the tax structure on petrol as Goa has done in the past.