Crude oil prices have retreated from the $147.27 per barrel high of July 11, but that they might scale new heights yet again remains a definite possibility, confronting the Indian economy with a whole new set of daunting challenges. Still, when comparing how our economy has responded to global oil shocks in the past and the present, it seems that we are becoming more resilient to such shocks.
Back in 2000, the IMF had predicted that every $5 a barrel (20% at that time) per year increase in international oil prices would reduce India?s GDP growth by 50bps. But despite the global oil price spiking since then, the Indian economy has continued marching ahead with little signs of slowing down. India?s oil basket price has risen by an astronomical 253.57% between 2001-02 and 2007-08. Meanwhile India?s GDP growth rate has remained undaunted, rising from 3.8% in 2002-03 to 9.6% in 2006-07, slowing down a little to 9.0% in 2007-08 (see graph 4).
In January-June this year, global oil prices rose 50% over the 2007 average. But as chief economist with Anand Rathi Financial Services Sujan Hajra argues, ?we are not experiencing the kind of crisis that was seen during earlier global price shocks. This time around, a fortuitous set of circumstances, ranging from huge forex reserves to a healthy capex ratio, have provided us plenty of protection so far.? Crisil principal economist DK Joshi agrees: ?Unlike in the past, the Indian economy has shown resistance to rising global oil prices.?
Joshi explains that this resilience is the result of more industry efficiencies. Also, the hike has not been totally translated to the domestic economy where consumers continue to be protected from the real price rise. As for directly effected industries, such as the airline sector that is really feeling the impact of rising ATF costs, they have had no choice but to somehow keep coping. ?But overall we haven?t dealt badly with an almost $150 a barrel scenario that would have amounted to a doomsday situation a few years ago,? he says.
Goldman Sachs?s India economist Tushar Poddar argues that shielding the economy from oil shocks are not only govenment subsidies but also a massive fiscal stimulus via steps like the rural employment scheme and the civil servants? pay hikes, to say that he doesn?t expect growth activity to slow sharply.
Backing up this argument is a new Assocham survey revealing that higher inflation, interest rates and fuel costs have hardly deterred the High Income Group from spending lavishly on shopping, amusement and eating out. The catch: Middle-class Income Group has curtailed its spending on such heads by nearly 55% in the last year.
Crumbling resistance?
Suddenly however we are being pummeled from all directions, by rising inflation and growing government deficit, widening current account deficit and slowing growth, rising interest rates and a weakening currency. So the question is whether our aforementioned resilience is sustainable. Hajra warns that, ?we will begin to feel a stronger impact now as imprudent fiscal governance and subsidies take their toll.?
Joshi argues along the same lines: ?There is only so far we can run from the ill effects of not reforming the petroleum and fertilizer sectors. Among the many impacts of this failure, we now find that project liabilities have grown enormously. And even if oil prices stay where they are today, these liabilities are here to stay too. The fact that they are assuming a permanent character is not good for the fiscal at all. ?
Goldman Sachs has reduced its GDP growth forecast for FY10 to 7.2% from 8.2% due to a weaker investment outlook, caused by much higher interest rates. It has also raised inflation forecasts for FY09 to 11.5% from 10% and for FY10 to 5.3% from 4.7%. Poddar says, ?A key risk to our FY09 forecasts is oil. Given that India imports nearly a third of its oil usage, higher than forecast oil prices could lead to interest rates rising even more than our current expectations, with further downside to activity.? And his is just one of the various consultancy firms that have accordingly begun downgrading their India projections.
What lies ahead?
Most analysts are wary of predicting future oil prices. But Lehman Brothers estimate that prices will average $113 a barrel in FY09. Their India economist Sonal Varma says: ?We are already seeing the impact of the price hike across all key channels, but the oil import bill will only keep rising.?
On current account deficit, Varma projects that it will rise from the current 1.5% to 3% of the GDP by next year. Not too surprising given that the Indian crude basket for this year?s April-June quarter stood at $118.50 a barrel as against $77.25 a barrel last year, and that our trade deficit has widened to $9.78 billion. Morgan Stanley says that the fiscal deficit will rise to 11.4% of GDP in the fiscal year ending March 31, up from an estimated 7.7% in the previous year. Already in the first two months of the financial year, the government?s fiscal deficit has crossed 50% of the budgeted deficit for FY09.
On currency, Morgan Stanley has reported that even if the crude stabilises at $100 a barrel, the Indian rupee will be one of the ?first to go,? along with Indonesia?s rupiah and the Philippine peso, as these Asian governments face growing difficulties in sustaining subsidies. India is in a worse situation than China, Hong Kong and Singapore that have substantial current-account surpluses. Most analysts predict that India will nonetheless persist with the domestic ceiling on petroleum prices.
For now, Indian exporters are benefiting from a weaker rupee, which has declined 7.3% this year. Exports actually grew by 23.5% in June, accelerated by companies shipping more gems, oil and other manufactured products to overseas markets. The catch: imports increased by 25.9%, with oil imports shooting up to $9.03 billion in June this year from $5.89 billion last June.
Assocham has said that our import bills will be broadly offset by exports of petroleum products, which have been rising significantly since FY05 when they grew 96% and which are expected to grow substantially after the commissioning of Reliance refinery at Jamnagar. But Hajra is less sanguine: ?India has currently only passed through to domestic consumers less than 10% of the cumulative impact of the international oil price rise.? This is much less than the pass through of 20% in the 70s, 100% in the 80s, and 57% in the 90s. He says that if the full impact of the oil price rises since FY05 was to be passed through, its direct impact alone would raise WPI inflation to 16%.
Oil dependency and subsidies
In 1978, US and Europe consumed almost 75% of the world?s oil output. Following the 1980s oil shock, this figure started dropping and came down to less than 50% by last year. This May, in the wake of skyrocketing oil prices, Americans drove about 10 billion miles less than in the same month last year, with energy efficiency also becoming a top priority for industry. But the newest energy efficient technologies are not easily transferable to India because of proprietary concerns. And as for demand, it shows little signs of slowing down in India or China
In China, demand rose by 400,000 barrels a day between the first quarters of 2007 and 2008. As for India, amongst developed and emerging economies of the world, it unfortunately leads the pack in terms of oil imports to total imports ratio (see graph 3). In fact, as Hajra points out, ?India?s current ratio at 34% is almost three-times the global average. This, coupled with low price elasticity of oil demand, makes India highly vulnerable to high oil prices.? There is a silver lining or two on the horizon. Hajra himself points to the one that lies in the substantial natural gas discoveries and prospects for more: ?If the gas story pans out as we expect, it could boost India?s annual growth by 50bps, reduce the trade deficit, and result in an eventual current account surplus.? But for now, the government has issued bonds equivalent to 3.6% of GDP to compensate oil and fertilizer companies selling their products much below global prices.
Joshi says he does not see this situation changing, not in the near future: ?Perhaps when the next government comes, it will be in a better position to reform the petroleum and fertilizer sectors. But I don?t see this happening in the next six months. After all, the recommendations of Rangarajan and Chaturvedi committees haven?t had much impact on our policies so far.?
He continues, ?meanwhile all we can do is hope and pray that global oil prices don?t rise any further. If they do, the government will be forced to cut its spending. And we know that spending cuts will mostly come from investment rather than consumption activities.? Once such cuts begin impacting investment in projects ranging from roads to power plants, this infrastructural slowdown will in turn effect India?s growth.
As to why the government has not heeded this sage advice, Varma puts it succinctly: ?Although high oil prices have acquired a permanent character by now (this is also the RBI view), the fact is that India has a lot of poor people. And this makes the question of reducing subsidies a politically tough nut to crack.?