Rising crude prices pose inflation concerns for India amid West Asia tensions

Escalating crude oil prices are causing growing apprehension not only in India but also in its stock market. The surge in oil prices is raising concerns about the potential consequences, notably the threat of inflation, in the wake of ongoing tensions in West Asia thanks to the Israel-Hamas war.

Since India relies heavily on imported crude oil, any sustained uptrend in oil prices due to the turmoil in West Asia could have profound implications for the nation's economy and its stock market, say experts.

India's dependence on imported crude oil is striking, accounting for nearly 85 per cent of its consumption. This significant reliance on global oil markets has raised alarm bells among economists and policymakers who fear the potential repercussions of this vulnerability.

The Israel-Hamas conflict has introduced a new layer of global challenges for the Indian economy. Since the conflict's initiation, international crude oil prices have surged by more than 5 per cent. This upward pressure has been further compounded by US bond yields reaching a 16-year high, adding to the woes of the oil market.

Recent announcements from major oil producers like Saudi Arabia and Russia regarding oil supply cuts to the tune of 1.3 million barrels per day until the year's end have created an oil market deficit. Coupled with oil prices hovering above USD 90 per barrel, this situation raises concerns, especially within the context of the global economy's "higher for longer" interest rate scenario.

Rising oil prices have a domino effect on various industries, impacting the cost of production and increasing energy costs for businesses and households. This surge in energy prices contributes to higher global inflation rates, creating complexities for central banks striving to maintain control.

In response to these developments, central banks worldwide may resort to raising interest rates, a move that could ultimately hamper global economic growth.

Countries heavily reliant on oil imports, such as the United States, India, and China, are at risk of experiencing substantial import inflation as oil prices climb. This scenario may result in a trade deficit, as India would need to allocate more funds for oil imports, adding pressure to the country's current account balance.

Shantanu Bhargava of Waterfields warns, "High crude oil prices hurt India, impacting currency stability, possibly worsening the government's fiscal deficit (as the government may consider cutting excise duties), widening the current account deficit, and affecting the profit margins of sectors such as aviation, paints, tyres, and chemicals."

The current account deficit (CAD), a key indicator of a country's balance of payments, could potentially widen by 0.5 per cent for every USD 10 increase in Brent crude prices, according to market experts. Dr VK Vijayakumar, chief investment strategist at Geojit Financial Services, emphasises the impact, stating that "every USD 10 increase in Brent crude prices expands India's current account deficit by 0.5 per cent, consequently depreciating the rupee and leading to imported inflation."

The strengthening of the US dollar against other currencies, including the Indian rupee, owing to higher oil prices, further complicates India's economic landscape. Since India pays for its oil imports in dollars, a substantial oil import bill increases the demand for dollars, potentially weakening the rupee against the dollar.

Should the upward trend in crude oil prices continue, it could have significant implications for specific stocks and the broader Indian economy. The Indian crude oil basket, which averaged around USD 80.1 per barrel in the first five months of the fiscal year 2024, briefly touched USD 90.7 per barrel in the first week of September. If Brent crude prices remain elevated throughout the fiscal year, experts anticipate the full-year average price for the Indian crude oil basket to be approximately USD 86-87 per barrel.

Elevated international oil prices are expected to raise the average Indian crude basket price, resulting in losses for oil marketing companies such as Indian Oil, Bharat Petroleum Corp Ltd, and Hindustan Petroleum Corp Ltd. To mitigate the impact, these companies are likely to absorb a portion of the elevated global crude prices.

Moody's Investors Service recently noted in a report that while crude oil prices are surging, petrol and diesel prices in India are expected to remain stable in the lead-up to the Lok Sabha elections next year. India's three state-owned fuel retailers, collectively dominating approximately 90 per cent of the market, have maintained a freeze on petrol and diesel prices for an unprecedented 18 consecutive months.

This pricing policy, sustained despite a surge in crude oil costs, has been a source of heavy losses for these companies during the first half of the 2022-23 fiscal year. However, as oil prices eased, the companies returned to profitability. Nevertheless, with international oil prices regaining strength since August, the profit margins of these three retailers have once again come under pressure.