Thursday, September 10, 2015

Will the crude oil windfall make the “India Story” complete?

Will the crude oil windfall make the “India Story” complete?

Anoop Swarup
Anoop Swarup
It is said that economic theories are only good for academics but not for intelligent animals and of course not for real world politics. Are the ‘acchey din’ (good days) here again? Well a lot will be incumbent on the policy response to the drop in crude oil prices, well over 25% since July that means a cumulative saving of USD 10 billion or INR 61000 crore for the Indian economy. Surely, this is a windfall for a country like India, which has large oil import needs and external adjustment pressures that also impact its overall credit ratings. No wonder external agencies such as Fitch Ratings are now painting a rosy picture with better economic growth prospects, improved terms of trade provided that the lower prices are sustained below USD 90/bbl through 2015, as being forecast.

But there is a lot more than what meets the eye! Incidentally this month’s production output has been the highest for the last two years by OPEC at 31.06 million bpd according to Reuter’s surveys. Latest reports suggest that the weighted average marginal cost of oil at Shale dominated onshore at USD 73 a barrel plays an important role in fixing international oil price and therefore a short position now will play a major role for a rally later as observed in case of gold. Also, paradoxically there would be a big winner in the US oil industry and the US consumer who gain a rebate of almost USD 600 per household in case Brent crude falls to USD 80 per Barrel. Yes, there would be an income boost to the BRICS as also the emerging economies as their net oil import bills are significant. On the world stage the global economy is set to have a daily windfall of USD 1.8 billion dollars.
The big question remains whether or not the impact will be passed on to the consumers for positive consumption effect as the lower oil prices may not only help in lowering inflation but also may act as a trade offset. Our policy makers have the twin challenge to bolster growth while reducing the external account deficits. Thus in India the diesel prices were rightly enough, deregulated on October 18 and the direct impact on headline fiscal forecast is expected to be limited making the fiscal accounts more robust against future oil shocks as both diesel and petrol prices will now be determined by the markets. Unlike in Indonesia where President Joko Widodo raised the administered price by over 30% recently to cater to the fuel subsidies and to implement his reforms agenda, to make the best of this happy reversal of fortunes, India is yet to come up with some very ingenious measures to make the best of the fortune.
Let us also have a brief overview of the impact of such a fall in countries other than India. Lest we forget, the collapse of Soviet Union in 1991 was preceded by a fall in price of oil, its main export by two thirds during 1980 and 1986. Likewise oil producing countries such as Iraq, Syria, Nigeria and Libya, now are in turmoil as the price of Brent crude fell over 25% in the last three months and for countries such as Saudi Arabia their budgets may go into red as this translates into a yearly loss of 100 billion USD in export income. Venezuela wants oil at USD 120 barrel and Iran at USD 135 a barrel to sustain their spending plans. Even emerging economies like Brazil want to have high oil prices to attract investments for its deep offshore oil reserves.
The assumption is not off the mark that though a windfall for some, at least half the world economy may face a slowdown with crude oil prices at historic low. On a strategic front it is held that by 2018 the US crude will replace the entire Middle East production that will also help the US save its dollar from being replaced as a reserve trading currency. Similarly, Russia has much more to achieve on the strategic front with higher defense and military spending in recent years that can be met only by higher production and higher prices currently estimated at USD 130 a barrel for its sustainability. There is no denying the fact that sovereign funds accumulated over the years by the Middle East and Arab world, have been a threat to the US and the European economies. Thus there appears to be a competing drive to achieve more production outcomes rather than just the debt sustainability that is ostensibly professed by these nations.
In order to sustain crude at levels of USD 120 there have been concerted and frantic efforts by many oil majors that need a potential capital spend of over 550 billion USD in the next ten years for newer projects and to keep pace with higher oil field service bills. Thus there is an imminent danger of a price war that will keep pace with a cold war between major oil exporters. The aggressive Russian posturing and the latest air strikes by the US in Syria at targeted oil facilities controlled by the ISIS may be a pointer of the shape of things to come. Mathew Levitt, a former US financial intelligence official has reportedly stated that ‘the ISIS is probably the wealthiest terrorist group we have ever known’ as it now controls a huge swath of land area that is now bigger than the UK and has enormous revenue currently estimated by Iraq Energy Institute at over USD 3 million a day from the oil resources that it controls and the discounted sales in the black market at USD 40 a barrel.
No wonder that the reason why crude prices are on the down swing now need no further elaboration. Let us now examine the policy imperatives and a strategic plan for India at this juncture. Of course India needs superb storage facilities for a time when crude price may hit the roof in the international market as also better exploration outcomes and efficiencies in existing production. Developing alternative energy resources particularly for the agriculture and agro-business sector may be a necessity as in the near future the world economy will have a predicted slow down with consequential impact on India. Also on the downside is also the fear of a unemployment due to a prolonged and massive slow down of global economy. We may at this stage question RBI about cutting down interest rates as the economy is now in terms of the FRBM as promised during the last budget.
For India, though the India story gets a boost when global growth is weakening, the twin deficits–current account and fiscal–will surely moderate and inflation will decline with liquidity in the banking system likely to improve leaving more room for cutting interest rates. Yet there is no need for complacency–notwithstanding the jubilation among the public over Prime Minister Narendra Modi’s much publicized India story because its too early in the day and the story is far from complete! Indeed there is the conventional wisdom, but there are pertinent issues that we should not be losing sight of. As it is perhaps the conventional wisdom that has held us back all these years! Now since the global crude prices are low and are expected to be below USD 100 until March 2015 based on the reports from the world market in view of the low productivity and demand in the US, Europe and China. Finance Minister Arun Jaitly may well have an opportunity as India’s emerging economy not only needs more crude from abroad but also the surplus funds that would now be available for investments in well thought out policy initiatives to break from the ghosts of the past.
The crude war is indeed dirty. There are so many challenges and we may have little to smile at due to the dark clouds that loom on the horizon.The drop in crude oil price has given an opportunity that we cannot afford to throw away by inadequate policy response.

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