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  1. Crude at $100: Kotak’s three-pronged strategy to fill in the oil hole

Crude at $100: Kotak’s three-pronged strategy to fill in the oil hole

Oil price doubling to $100/barrel could mean an increased outflow of $90 bn annually. In a note Kotak Institutional Equities said that extra dollars are required to fund the increase in net crude imports.

By: | Published: June 27, 2016 2:42 PM
IEA Oil market Report, IEA News, IEA Oil News Kotak builds a scenario of oil going back to 0 to see how India’s current account could look. It also details the steps India should prepare irrespective of this eventuality. Kotak believes that the current account could weather an oil spike; action could shift to the fiscal if oil boils. (Reuters)

Oil prices could remain stable or rise as a supply overhang that pulled down prices by as much as 70 percent between 2014 and early 2016 is gradually brought down, bringing production back in line with consumption. So, how should India prepare for $100 oil? What if there is a scenario of oil rising steadily over the next few years to say $100/barrel by FY-2020?

Oil price doubling to $100/barrel could mean an increased outflow of $90 bn annually. In a note Kotak Institutional Equities said that extra dollars are required to fund the increase in net crude imports. The estimate suggests that India’s net crude import bill could rise to $142 bn from $52 bn in FY2016, an increase in outflow of $90 bn annually, or 3.2% of the then expected GDP of India. This increase in prices of oil will also help in increasing the value of petchem and refined crude exports.

Kotak builds a scenario of oil going back to $100 to see how India’s current account could look. It also details the steps India should prepare irrespective of this eventuality. Kotak believes that the current account could weather an oil spike; action could shift to the fiscal if oil boils.

We take a look at Kotak Institutional Equities’ three-pronged strategy to fill in the oil hole:

Many sectors need to power the exports story

Industries such as agriculture, chemical products, gems and jewelry, textiles and transport equipment will need to lead the India export story. Kotak expects horticulture exports to become an important part of the agriculture export story adding to the portfolio of rice, meat and mangoes: this will require India sprucing up its own phytosanitary standards. Garmenting requires a large push in textiles for India to gain market share in the $800 bn+ textile export market: this will require introducing flexibility in labor laws to make the sector agile. It expects that the large capacities set up by many foreign auto players (banking on India’s frugal engineering) will be used to build an export base for Africa, east Europe and Latin American markets. Pharma and jewelry sectors are expected to build on their traditional strengths although the former will require better compliance with stringent FDA requirements.

Make in India will need to be a roaring success

Two key changes will be required: (1) a resurgent production from Coal India and its evacuation such that coal imports come down and (2) a sharp fall in import of electronic items – a key component of the Make in India initiative. Kotak models a 15% annual decline in the value of electronic goods import – this will require significant investments in local sourcing by companies that currently simply import the stuff into India. White goods electronics, mobiles and telecom equipment form a bulk of this import component. It expects gold import to remain broadly constant: if the real interest rates remain positive for a sustained period of time, possibly the ‘investment’ in gold can come down. It also involves a model of leveling-off of machinery imports – this rests largely on the plans of various industrial companies wanting to make India an export hub.

Services sector to the rescue again

India’s services sector has been the bulwark supporting its current account. Kotak expects the revenues of software exports to go up – a conservative 5% annual growth. If the oil prices were to spike up again, there would be an uptick in the remittances coming in from the oil-producing countries – almost half the remittances to India come in from these nations. Of late the invisible services imports have started to inch up.

Kotak says that low oil prices over the past couple of years have helped the government build up fiscal reserves and eliminate subsidies across many fuel products (diesel, gasoline among the major fuels). Depressed energy prices have also helped calm inflation through both direct and indirect effects. A sharp spike up in prices, especially if near the general elections in 2019, could test the building up of fiscal buffers via the increased excise duties.

Kotak highlighted that countries that ended up as ‘Fragile Five’ were those that had poor current account and fiscal dynamics – India should make use of the current oil price bonanza to make a clean break from such a group.

Oil prices have been under pressure, adding to the downward pressure on crude is the strengthening of the dollar, with traders fleeing to the currency’s relative safety. A stronger dollar makes dollar-priced commodities like oil more expensive for those using other currencies.

Despite this, Morgan Stanley added that “the medium term trend towards oil market rebalancing appears in place, barring a recession.” This implies that oil prices would likely remain stable or rise as a supply overhang that pulled down prices by as much as 70 percent between 2014 and early 2016 is gradually brought down, bringing production back in line with consumption.

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