Why is crude oil an important factor in India’s growth story?

You are currently viewing Why is crude oil an important factor in India’s growth story?

Oil is one of the most important commodities essential for any economy due to its wide usage. In a growing economy like India, the demand for oil is also expected to increase at a healthy pace. However, India depends majorly on imports to fulfil its oil demand. In FY19, the oil imports accounted for 84% of its total oil requirement which is an increase from 77% in FY13. This is despite the government’s constant focus to reduce imports and increase domestic production; however, we are yet to witness any meaningful growth in production output.

So how does crude oil prices affect India’s growth story?

The government plays a crucial role in promoting growth in the economy as it uses the revenue to fund various Infrastructure, Agriculture and Social programmes. The taxes from fuel forms an integral part of the government’s revenue. If one had observed, over FY14-18, crude prices had corrected over 70% from ~110 dollars per barrel and rupee depreciated by 10%; however fuel prices across India were lower by merely 10-12%. The fuel price decline was restricted as the government increased the excise duty during the same period. This led to higher spending by the government which steered economic growth during the period. Therefore, lower crude prices not only reduce the subsidy burden for the government, but increased excise duty also aids revenue for the government. This is then used to fund various programmes.

Fact: The tax collected crude oil and petroleum products from in over FY15-19 surpassed the overall subsidy provided by the government in the last 15 years. The tax on crude oil and petroleum products increased to ~Rs. 2.96 lakh cr in FY19 as against ~1.26 lakh cr in FY15.

What happens if crude prices inch higher?

Firstly, the impact of higher crude prices is directly on India’s current account as a higher import bill leads to widening of deficit. This leads to a higher demand for USD and makes Indian currency cheaper. Secondly, if the government decides to pass on the entire increase in crude prices then it would adversely affect inflation. However, if the government absorbs, then it would lead to higher fiscal deficit as the government need to provide for subsidies.

In this case, the government can decide to either widen the fiscal deficit target for a FY or reduce spending to meet the fiscal deficit target or it can pass the burden of increased oil prices to OMCs. The last option is a temporary solution but can be used by the government (done in October 2018) as most of the OMCs in India are PSUs. The other two measures are detrimental to the economy as reduced spending could drag growth lower. Further, increase in deficit can lead to higher inflation and interest rates. Therefore higher crude prices definitely have negative repercussions on the Indian economy. In either case, the growth momentum is impacted adversely. Hence, we have seen the stock market and currency market react negatively crude surpasses a certain threshold level (threshold level near 75-80 dollars per barrel).

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