In a welcome development for the Indian economy, global oil prices have witnessed a decline, offering a significant boost as the nation heavily relies on importing over 85% of its crude oil needs. Despite ongoing geopolitical uncertainties in West Asia, this downturn comes as a major positive for India.
The volatility In oil prices has long been identified as a potential downside risk to the economy. Costlier imports not only contribute to domestic inflation but also weaken the rupee, necessitating more US dollars for import payments.
The trajectory of the Indian basket of crude oil imports had been on the rise during July-October 2023, following production cuts by the OPEC+ oil cartel. However, a global economic slowdown has led to a decrease in demand, causing prices to fall once again.
Throughout October 2023, the average price of the Indian crude oil basket was $90.08 per barrel, with September seeing a slightly higher average of $93.54 per barrel. In comparison, the benchmark Brent crude in the international market has now dropped to $77 per barrel, indicating a notable decline.
The current situation is a delicate interplay between geopolitical tensions, such as those arising from the Israel-Hamas war, which typically tends to drive oil prices higher. However, it is the softening demand that ultimately results in a reduction in prices.
Government Chief Economic Advisor V. Anantha Nageswaran expressed optimism, stating that oil prices do not pose a major downside risk for the Indian economy in the next financial year (2024-25). He highlighted the relevance of geopolitical situations and cargo movement in the Red Sea but emphasized that slowing demand could counterbalance any potential surge in prices.
Nageswaran added, “If prices rise, they will further cool down the economic activity,” underlining the intricate relationship between energy prices and economic dynamics.
Economists suggest that a 10% surge in oil prices from the baseline of $85 per barrel could weaken domestic growth by 15 basis points and increase inflation by 30 basis points. Leading global investment bank Morgan Stanley estimates that every $10 increase in oil prices raises India’s inflation by 50 basis points, assuming these higher costs are passed on to consumers. This also widens the current account deficit by 30 basis points.
Given the potential economic impact, the Reserve Bank of India (RBI) had previously hiked the policy repo rate by 250 basis points between May 2022 and February 2023 to combat inflationary pressures. Although the rate has remained steady at 6.50%, the RBI remains focused on lowering inflation to the 4% target.
As the central bank projects inflation at 5.4% in fiscal year 2023-24, based on an average crude oil price of $85 in October-March, any increase in crude oil prices could delay interest rate cuts aimed at stimulating economic growth. Conversely, a decline in crude prices, leading to lower domestic inflation, could prompt an earlier reduction in interest rates to invigorate economic activity.
In conclusion, the recent dip in global oil prices offers a respite for the Indian economy, providing an opportunity for economic rejuvenation and potential policy adjustments in response to changing energy dynamics.