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Falling crude prices to pump up Narendra Modi's economic recovery efforts

Wednesday, 27 August 2014 - 7:15am IST | Place: Mumbai | Agency: dna

The National Democratic Alliance (NDA) which came to power with an absolute majority, primarily keeping development as agenda, has a reason to rejoice.

The recent sharp contraction crude oil prices has come as a blessing for the government in its continued battle with the inflation demon.

Brent crude has fallen sharply from the high of $115 per barrel in June to a shade below $100. A recent communication from Petroleum Planning and Analysis Cell (PPAC) said crude oil price of the Indian basket has also come down to $99.94/barrel.

In rupee terms also, the price of the Indian basket fell to Rs 6,069.36 per bbl in the middle of last week from Rs 6,108.44 per bbl a day earlier.

Economists explained that the fall in crude prices is going to bring three pronged benefits for the Indian economy, which imports 85% of its crude requirement. The fall in crude price is expected to bring down current account deficit (CAD), because of lower import bill, oil subsidy burden and overall inflation.

"India is one of the most vulnerable economies when it comes to oil. Fall in crude prices is definitely going to help in controlling current account deficit as import bill will go down.

Lower oil prices also mean lower subsidy burden for the government. Now it will be even easier for the government to completely deregulate diesel prices," D K Joshi, chief economist with ratings agency Crisil, said.

The 2014-15 budget estimated India's subsidy bill at Rs 2.6 lakh crore, or 2.03% of gross domestic product (GDP), with oil subsidies amounting to Rs 63,500 crore. Food subsidies of Rs 1.15 lakh crore and fertiliser subsidies of Rs 73,000 crore were the other major components of the subsidy bill.

If the drop in crude price sustains and volumes do not pick up substantially, a meaningful impact could be seen on CAD and oil subsidy bill of government. Indian oil marketing companies sell certain petroleum product like diesel, liquid petroleum gas (LPG) and kerosene at lower than market prices, leading to under-recoveries for which they get cash subsidies from government.

Diesel under-recoveries are likely to become nil over two months as the government has been increasing widely used auto fuel's prices over past nine months by 50 paise every month, bridging the gap with current market prices. If crude continues to fall and if government market links diesel prices, then diesel prices would also fall in line with crude prices, which is likely to ease current high inflation level.

Sajjid Chinoy, chief India economist at JP Morgan estimates that, as a broad rule of thumb, a $10 decrease in crude prices over a year would result in a reduction of annual oil under-recoveries of about Rs 35,000, which should translate into fiscal savings of about Rs 18,000, or 0.15 % of GDP. Such a decrease in crude is also likely to initially bring down oil imports by about $15 billion. So a sharp drop in oil prices -- if sustained -- can have a meaningful impact on helping India's twin deficits, Chinoy said.

India's crude oil imports rose to Rs 864,875 crore (around $143 billion) in 2013-14 from Rs 784,652 in 2012-13.

"Large ecosystem in the country depends on crude. Drop in crude prices would bring down input cost of manufacturing and industrial goods, transportation cost, which, in turn, will help in controlling inflation," Saugata Bhattacharya, chief economist of Axis Bank, said.

"Fall in crude price may see immediate impact on WPI (Wholesale Price Index) inflation, but it would be reflected in retail inflation only with lag effect," Chinoy said. Fuel and power currently have 14.91% weightage in WPI inflation.

Economists believe that crude price fall may not have any direct impact on fiscal deficit, but it would make slightly easier for the Modi government to achieve the target. It will still require lot of divestment to achieve fiscal deficit target of 4.1% of GDP this fiscal as against 4.5% of GDP in the previous year.

"If the fall in crude price sustain, then it will smoothen the economy recovery path for the government. Crisil in a recent report had predicted that crude prices may remain in $90-$100 per barrel bracket by 2018," Joshi said.

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