Economists feel a prolonged conflict in West Asia could push crude oil prices beyond India’s comfort zone.
| Photo Credit: Getty Images/iStockphoto

The story so far: The Indian economy, measured in terms of the Gross Domestic Product (GDP) as well as Gross Value-Added (GVA), grew 7.8% between April and June (first quarter or Q1) this year, a four quarter-high. The Finance Ministry believes the momentum of economic activity was carried forward in the July-September quarter, despite retail inflation hardening to 6.4% from 4.7% in Q1 thanks to a spike in food prices. Growth estimates for Q2 will come in next month, but the Reserve Bank of India (RBI) expects GDP growth to moderate to 6.5%. A week into the second half of the year, the Israel-Palestine conflict erupted and a spate of fresh dark clouds now hover over the economy.

How have experts reacted to recent events?

Economists feel a prolonged conflict in West Asia could push crude oil prices beyond India’s comfort zone and if other countries join the fray, critical sea routes could face disruptions and spike transport and insurance costs. The government may not pass on higher petroleum prices to consumers ahead of critical elections, but producers’ costs may still rise. Airlines, for instance, have been hiking fares in line with aviation turbine fuel costs. Moreover, higher fuel import bills could pose implications on the exchequer as oil marketing companies may need support for under-recoveries. Finance Minister Nirmala Sitharaman, in her first remarks since the strife in Gaza, said it has brought concerns about fuel, food security and supply chains back to the forefront. She flagged concerns about the impact of any disruptions on inflation in the near future. In subsequent comments, she has also emphasised the need to ensure that global food, fertilizer and fuel supplies did not become an “instrument of war and disruption”.

The RBI Governor Shaktikanta Das, who chaired a monetary policy review hours before Hamas launched the first salvo in the conflict, summed up the emerging situation eloquently. “We all thought that the period of uncertainties is over, but as you would have seen in the last fortnight, new uncertainties have been thrown up while some that already existed, like oil prices and volatility in financial markets, have got more pronounced,” he said last Friday. Among the new uncertainties, he listed the spurt in U.S. bond yields that hit a 16-year high this month and mixed global data points amid fears of “higher for longer” interest rates. A cut in India’s interest rate is not on the cards, he emphasised. “Interest rates will remain high… how long… only time and the way the world is evolving, will tell.” Higher interest rates can impact investment flows in markets like India.

Is there a shift in the assessment of risks for the economy?

The International Monetary Fund (IMF) raised its 2023-24 GDP growth estimate for India to 6.3% this month from 6.1% estimated earlier. This is just slightly below the 6.5% GDP uptick the Finance Ministry and the RBI have penned in for this year, following last year’s 7.2% growth. In its monthly economic review report released last month, the Department of Economic Affairs (DEA) in the Finance Ministry said it was comfortable with the 6.5% hopes “with symmetric risks”. Bright spots of corporate profitability, private sector capital formation, bank credit growth and construction sector activity offset the risks at the time. These included steadily climbing crude oil prices (“but no alarms yet”) and an overdue global stock market correction, which it termed “an ever-present risk”. The RBI, this month, also asserted that risks from the uneven monsoon, geopolitical tensions, global market volatility and economic slowdown, were “evenly balanced”. The RBI expects GDP growth to slow to 6% in the current quarter, and further to 5.7% in January to March 2024 before picking up to 6.6% in Q1 of 2024-25. Governor Das has since exuded confidence in the overall macro fundamentals of the Indian economy, despite the uncertainties that have emerged this month.

Last Monday, in its latest economy review, the DEA noted that though domestic fundamentals are strong and improving, downside risks arise from global headwinds that have been compounded by recent developments in the Persian Gulf, and uncertainties in weather conditions due to El Niño effects. “Depending on how the situation develops, crude oil prices may push higher. Further, the relentless supply of U.S. Treasuries and continued restrictive monetary policy in the U.S. (with further monetary policy tightening not ruled out) could cause financial conditions to be restrictive,” it said. It was also prescient about the U.S. stock markets having a greater correction risk, which would have spillover effects on other markets. India’s stock markets clocked six straight days of sharp declines before a marginal recovery was seen this Friday. The DEA has flagged a broader worry about fraught geopolitical conditions triggering a surge in risk aversion. “If these risks worsen and are sustained, they can affect economic activity in other countries, including India,” it noted, even as it averred that India’s growth story remained on track. Inflation had eased to 5% in September from a 15-month high of 7.4% in July and the department highlighted higher upticks in industrial capacity utilisation levels, private consumption and investment, retail loans extended for vehicles and housing as bright spots in its economic outlook. The report also cited ‘optimistic’ findings from RBI’s forwarding-looking surveys on manufacturing, consumer confidence, employment and inflation expectations to stress all is well.

What are domestic factors to watch out for?

Inflation may have subsided last month, but could creep back up. The RBI, which expects average inflation of 5.4% through 2023-24, has penned in a 5.6% average uptick in prices for the October to December quarter and 5.2% for the first six months of 2024. While some vegetable prices have corrected, inflation in onions has shot up while for pulses and some cereals, prices are likely to stay high for a while. The IMF and World Bank expect inflation to average even higher at 5.5% and 5.9%, respectively. The RBI’s preferred 4% inflation mark remains elusive as do prospects of interest rate cuts. This doesn’t bode well for a sustained rise in consumption demand that is vital to revive private investments. A Bank of Baroda study on consumption trends shows that production of readymade garments, mobile phones, hair dye, shampoo, cookers and even ice cream, had declined between 12% to 20% in the first five months of this year. “Normally when inflation is high households tend to cut back on discretionary spending which is what is being seen today,” it noted. With pent-up demand effects fading, the next couple of months will determine whether consumption has actually picked up, the Bank’s economists said. Rural demand which has been lagging, will be important, and may come under more pressure if some crops’ output is affected. Last but not the least, an economist from a rating firm said, the upcoming election season could imply some slowdown in public capex in infrastructure that revved up the economy in recent quarters.

Oil pump jack is seen in front of displayed Israeli flag in this illustration taken, October 8, 2023.
| Photo Credit: Reuters

A protracted Israel-Hamas conflict could spur oil prices beyond India’s comfort zone and even if the government holds retail fuel prices ahead of critical elections, wholesale prices may spike and a higher import bill could pressure the rupee, according to experts.

Brent crude oil prices rose over 3% on Monday, crossing $87 a barrel even as equity markets around the world, including India, came under pressure as investors turned risk-averse and rushed to safe haven assets like gold.

Fears of a wider conflict between Israel and Hamas not only pulled down the NSE Nifty 0.72% or 141.2 points to 19,512.4, but also dragged trading volumes on the NSE to “the lowest in many weeks”, said Deepak Jasani, head of retail research at HDFC Securities.

Broad market indices fell more than the Nifty even as the advance-decline ratio fell sharply to 0.28:1, he added, stressing that the conflict is the latest negative trigger for markets that are already fretting about macroeconomic uncertainties in Europe and China, hawkish central banks and rising oil prices.

Also read: Israel-Palestine conflict LIVE updates on October 9

Beyond the short-term effect on markets, Bank of Baroda chief economist Madan Sabnavis said that if the war persists for even a fortnight or more, the oil dynamics will change. Crude oil prices going beyond $90 a barrel would pose trouble for the world economy as well as India.

“Iran joining the fray can affect the sea routes and push up transport and insurance costs. Higher crude prices will distort our balance of trade and current account deficit, thus putting pressure on the rupee,” Mr. Sabnavis noted.

For the government, there could be fiscal implications. With elections looming in several States and for the Lok Sabha in 2024, raising fuel prices may be an unlikely option, but higher costs will have to be absorbed either by oil marketing firms or the exchequer.

“Retail inflation can still be controlled by the government if it chooses to keep fuel prices unchanged. But wholesale price inflation will increase for sure. Some airlines have already increased fares after ATF price hikes, which is also inflationary,” the economist said.

Export earnings could also be hit as Israel buys around $5.5-6 billion of refined petroleum products a year from India.

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New Delhi:

The Israel-Hamas war is a reason for concern and will impact oil prices if the Middle East and Iran get involved, said PHD Chamber of Commerce & Industry’s (PHDCCI) Executive Director Ranjeet Mehta.

Brent prices have gone up, Mr Mehta said, adding, “The war will impact oil prices, and supply chains, especially if Iran, a major oil producer, gets involved. It will impact over global economy and India.”

“The war is definitely a reason for concern. Israel is one of our very good trading partners. If Iran and the Middle East get involved in the war, it will affect our oil supply chains. It will also impact the import of diamonds and other items from Israel. We also saw its impact on the stock markets today,” he added, flagging an imminent “atmosphere of uncertainty”.

“The atmosphere of uncertainty will prevail for a few days and we will get more clarity as days go by. Wars are unpredictable. With Israel declaring a state of war, the uncertainty will be there for a while now.”

Israel woke up to a dawn attack on Saturday, a day of Sabbath and a Jewish holiday, with over 5,000 rockets raining down as the Hamas group launched a land-air-water strike from the Gaza Strip.

Israel, caught off-guard, retaliated, promptly declaring a state of war and pounding Gaza with air strikes. Over 1,100 have died on both sides since Saturday and several thousand more have been injured.

New Delhi:

Oil prices hit a 10-month high of nearly USD 90 per barrel as Saudi Arabia and Russia extended their voluntary production and export cuts until the end of the year.

For a nation that is more than 85 per cent dependent on imports for its oil needs, the surge in prices means India will have to shell out more and the prospect of returning to market-driven petrol and diesel prices in the near future diminished further.

Brent crude prices surged around 6.5 per cent over the past week after Saudi Arabia, which leads the expanded OPEC cartel with Russia, decided to keep its one million barrels a day reduction in supplies to the global market until the end of December.

Russia has added its own voluntary export cuts in recent months.

The move has led to Brent rising above USD 90 a barrel for the first time this year on Tuesday. On Wednesday, it was trading at USD 89.67 per barrel.

The basket of crude oil that India imports has averaged USD 89.81 per barrel this month, up from USD 86.43 in August, according to oil ministry data.

The Indian basket was hovering in the range of USD 73-75 per barrel in May and June, rekindling hopes for a return to market-based pricing and a reduction in petrol and diesel prices.

But rates spurt to USD 80.37 per barrel in July and now to near USD 90.

“Public sector oil companies had been recouping losses they incurred for holding rates when crude oil prices shot through the roof last year. In May, international oil prices and retail pump rates had come at par.

“But now with the prices rising, the difference between cost and retail prices will reappear,” an industry official said.

India imports 85 per cent of its oil needs and its fuel pricing is indexed to international rates.

Petrol and diesel prices have been on a freeze for a record 17 months in a row. Petrol costs Rs 96.72 per litre in the national capital and diesel comes for Rs 89.62 a litre.

State-owned fuel retailers are supposed to revise petrol and diesel prices daily based on a 15-day rolling average of benchmark international fuel prices but they haven’t done that since April 6, 2022.

Prices were last changed on May 22 when the government cut excise duty to give relief to consumers from a spike in retail rates that followed a surge in international oil prices.

Sources said if international oil prices had stayed around USD 73-74 a barrel range, oil companies would have re-started daily price revision.

Higher prices would mean domestic producers like the Oil and Natural Gas Corporation (ONGC) get a higher price. However, the incremental revenues are likely to be ploughed by the government in the form of a windfall profit tax.

The tax, levied in the form of Special Additional Excise Duty (SAED), on domestically produced crude oil was reduced to Rs 6,700 per tonne starting September 2, from Rs 7,100 a tonne previously.

A windfall tax is levied on domestic crude oil if rates of the global benchmark rise above USD 75 per barrel.

Crude oil pumped out of the ground and from below the seabed is refined and converted into fuels like petrol, diesel and aviation turbine fuel.