Oil Prices and Indian Economy: Will rising oil hurt India's growth?

The crude oil price had touched 130 dollars a barrel earlier this year. It fell later and went below $85 per barrel in September. But now OPEC+, the oil-producing group, has decided to decrease oil production, which means oil prices may increase from the current levels. An increase in crude oil prices is never good for the Indian economy. 

What is the current oil price?

Oil prices jumped nearly extended gains on Tuesday, as OPEC+ considered reducing output by more than 1 million barrels per day (bpd) to support falling prices, with its biggest cut since the start of the COVID-19 pandemic. The demand for oil has fallen amid concerns of recession across the world. Let us look at how oil prices and the Indian economy are linked. Brent crude futures for December delivery rose $3.72 to $88.86 a barrel, a 4.4% gain. U.S. West Texas Intermediate crude rose $4.14, or 5.2%, to $83.63 a barrel.

Oil Prices and the Indian Economy

The Indian economy is impacted both directly and indirectly by rising oil prices. Below are the impacts of rising crude oil prices on the Indian economy:

Current Account Deficit: India imports more than 86% of its oil requirement. With the rise in crude oil prices, India's import bill will increase, and hence the CAD will widen (difference between import and export). As per ICRA, for every $10 per barrel increase in the price of the Indian crude oil basket, the CAD could widen by $14-$15 billion, or 0.4% of GDP.

Rupee exchange rate: The value of a free currency like the rupee depends on its demand in the currency market. This is why it depends to a great extent on the current account deficit (CAD). A high deficit means the country has to sell rupees and buy dollars to pay its bills. It reduces the value of the rupee - a falling rupee is never good for the economy (except for some sectors).

Rise In Inflation: International Energy Agency has said that a 10% increase in crude oil prices in India will lead to an increase in the Wholesale Price Index (WPI) by nearly 0.9%. There is also a significant impact on the consumer price index (CPI) with increasing crude oil prices. Hence, inflation increases with a rise in crude oil prices. The RBI and the Indian government are trying hard to bring inflation below the 6% threshold, but if oil prices increase, controlling inflation won't be easy.

Fiscal deficit: It is the difference between the government's earnings through taxes (direct & indirect) and the government's expenditure. If the government decides not to pass on the crude oil price hikes to the consumer, then, they will not increase the price of petrol. But someone has to take the hit. In this case, it will be the Indian government. It will lead to a fiscal deficit, and it is never good for the economy.

Forex reserves: India had great protection against any volatility in its balance of payments because of high forex reserves. Until recently, India had forex reserves of nearly $640 billion. However, rupee depreciation (because of increasing crude oil) is depleting India's forex reserves as the RBI has to sell dollars to control rupee depreciation.

Growth concerns: With increasing crude oil prices, inflation will increase, and to control inflation, the RBI will have to increase the interest rate. It will lead to lower spending, and hence the country's growth will come down. As per estimates, a rally of $10 per barrel in the India crude basket could lead to a 10 basis point fall from the annual GDP growth estimate.

Investors should monitor the crude oil prices since it impacts the broader economy, as we have seen above. Also, some stocks are directly impacted by crude oil prices. Hence, if you see crude oil prices going up, stocks that use crude oil as a raw material may fall.