Rising crude price a drag on equities as Sensex loses 5% in four sessions

Written by Devangi Gandhi | Mumbai | Updated: Feb 28 2012, 06:04am hrs
Even as the price of crude oil has touched the $125-per-barrel mark, equity markets in India have given up 5% in the last four sessions. Thats not surprising, given how hard rising crude oil prices can hit the economy. While the primary impact of increasing oil prices is higher inflation, assuming the government passes on the increased cost to consumers, a host of companies that use oil derivatives will be hurt.

The impact could particularly be significant for companies in sectors like petrochemicals and fertilizers since crude oil constitutes a bigger share of the raw material bill, ranging from 40% to 80%.

Equally important, elevated crude oil prices could stall the Reserve Banks plan of monetary easing in terms of interest rate cuts since headline inflation would be above the 7%mark and above the central banks comfort zone. There is market-wide expectation of RBI considering an interest rate cut as early as April. However, imported inflation based on global prices of commodities like crude oil, coal and base metals would be crucial for any such development. Crude oil prices, specifically, would be a key factor as every $10 increase in global crude oil prices strains our current account deficit by $8-9 billion, says Saravana Kumar, CIO, Tata AIG Life Insurance.

Kumar pointed out that auto sector could see the most significant impact due to higher fuel prices. The direct impact of higher crude oil prices would be felt by petrochemical, paint, fertilizer and tyre producers as they use various forms of crude oil derivatives as raw material components, he added.

The recent rally in the equity market since the start of 2012 ,which resulted in benchmark indices gaining nearly 13%, may be cut short if average crude oil prices for the quarter remain on the higher side. Higher crude oil prices could eat into India Inc's earnings in the coming quarters by further escalating inflation and, in turn, causing a postponement in the central banks proposed rate reduction exercise.

This is over and above the fundamental pressure higher crude oil prices can have on input cost, including that from a weaker rupee due to a possible increase in the current account deficit.

According to Andrew Holland, CEO-Investment Advisory, Ambit Capital, while higher crude oil prices could act as a setback for global economic recovery, India Inc stands to further feel pressure of higher inflation and elevated fiscal deficit. Higher crude oil prices from hereon could put the RBI in a dilemma to further balance slowing growth and high inflation levels. Even if they go ahead with an interest rate cut in the near future, elevated crude oil prices could turn more cautious and hamper down more rapid rate cuts, added Holland.

The historical data suggests that for the quarters when WTI ( West Texas Intermediary) crude oil, another benchmark, remained above $70, the return on Sensexs either stayed muted or was negative. On comparing the quarterly return on Sensex against the quarterly average prices of crude oil between 2003-2011, we observed that there were 17 quarters in the duration when the average price of crude oil was greater than or equal to $70 mark.

Notably, for 12 out of these 17 quarters (70% ), the return on Sensex was lower than or equal to 2%.