Falling crude to lower CAD by 25 bps to 0.7% in FY21: Report

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Updated: March 11, 2020 5:47 PM

Following Russia's decision not to cut production as suggested by the oil cartel Opec, Saudi Arabia has decided to up production and cut prices earlier this week, which led to a steep 30 per cent plunge in crude prices on Monday.  

crude oil prices, GDP, coronavirus outbreak, China, Opec, Saudi Arabia, GDP, world GDP growth, oil pricesCrude has fallen by over 45 per cent since the coronavirus outbreak in China since January, which has now spread to over 110 countries.

Falling crude oil prices will help reduce current account deficit by 25 basis points to 0.7 per cent of the GDP in FY2021, says the Wall Street brokerage Bank of America Securities. Crude has fallen by over 45 per cent since the coronavirus outbreak in China since January, which has now spread to over 110 countries.

Following Russia’s decision not to cut production as suggested by the oil cartel Opec, Saudi Arabia has decided to up production and cut prices earlier this week, which led to a steep 30 per cent plunge in crude prices on Monday.

The forecast is based on its assessment of crude trading at around USD 36 a barrel through the next fiscal, the brokerage said in a note on Wednesday, adding cheaper crude can potentially boost consumption by 0.4 per cent of GDP as well if the government passes on at least half of the price fall to end consumers.

The brokerage has also cut its FY2021 growth forecast for the country by 20 basis points (bps) to 5.4 per cent, and global growth to 2.2 per cent, down 60 bps. It has also slashed the country’s real GVA growth forecast by 10 bps to 4.8 per cent for FY2020 and by 20 bps to 5.4 per cent for FY2021. But if there is a global recession pulling down world GDP growth to 1.4 per cent, domestic growth in FY2021 will likely drop to 4.4 per cent, it warned.

Another plus of the falling oil prices is the likely repo rate cuts by the RBI at the next three MPC meeting to the tune of 25 bps each in April, June and October policy reviews. The brokerage also says the RBI should snap up more dollars to shore up forex reserves to guard against contagion and sees the reserves touching at USD 550 billion next fiscal.

“We estimate that a conservative RBI would ideally want the forex reserves at USD 550 billion. Lower oil should raise the RBI’s forex intervention by USD 6 billion to USD 31 billion in FY2021. As this constricts RBI OMO, we continue to expect the RBI to switch to forward purchases in the forex market to fund the fiscal deficit,” says the report. But on the negative, lower oil prices will snap FPI flows by USD 5 billion given the risk-off in financial markets, it warns.

“We see the drop in oil prices as relatively beneficial for the economy as it is a major oil importer buying almost 84 per cent of its domestic demand. We cut FY21 CAD by 25 bps to 0.7 per cent of GDP as we see Brent falling by USD 9 a barrel to USD 45. Lower oil prices also can potentially release 0.4 per cent of GDP for additional consumption in FY21” the brokerage said.

It expects the RBI to cut rates by 75 bps from 50-75 bps earlier and the US Federal Reserve by another 50 bps on March 18. A USD 7 a barrel plunge in crude should narrow the FY21 CAD down to 0.7 per cent of GDP, and if the fall is USD 10 a barrel then CAD should come down to 0.3 per cent of GDP.

This is because the oil subsidy bill could shrink to Rs 10,000 crore from Rs 40,000 crore in FY21 if the crude trends at USD 45 a barrel, saving USD 4.3 billion or 0.1 per cent of GDP. This can on the positive side boost consumption to the tune of Rs 1,00,000 crore or 0.4 per cent of GDP to consumption if the drop in oil prices is fully passed on to consumers. The government could withhold 33-50 per cent of the price drop to fund the fiscal deficit.

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