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Global Brent crude prices, which were already climbing on the back of supply cuts by key producers since 2H23, face the risk of further gains over concerns that the conflict between Israel and Hamas might expand to more regional players, especially the oil-rich Middle Eastern countries. Markets continue to weigh the impact of a weaker economic outlook by major economies into next year against supply management measures by OPEC+ members, just as fresh geopolitical risks emerge.

Impact on India

At this juncture, it is highly uncertain how long this conflict could last and the allies that might be involved in the face-off as the humanitarian costs mount.

The Middle East is an important trading partner for India, as the Gulf Cooperation Council (GCC) countries accounted for 19%, and others in West Asia (including Israel, Jordan, Lebanon, etc) made up 6% of total imports (see chart below) last year. The corresponding export share stood at 11% and 4%, respectively. Amongst the regional countries, two-way trade is most active with Saudi Arabia and the United Arab Emirates, particularly on petroleum/ crude oil imports, with the market share shifting towards Russia in the past year and a half, courtesy of hefty price discounts. As of FY23, India’s crude oil import dependency stood at 87.4% of total consumption.

The more significant impact of the conflict is likely through oil prices. The initial take of our Oil analysts (see house view) is that at the onset, neither of the countries involved in the conflict are oil suppliers, nor are they material on the demand map; hence, oil market fundamentals have not been directly affected. Concurrently, the conflict does not involve any oil trading routes despite its proximity to the Middle East. Oil prices are, therefore, trading with significant geopolitical risk premium in the near term on a perceived caution that more countries might get involved.

The average Indian oil basket eased to $82.5bbl in Oct (MTD) from $93bbl in Sep23, but the prevailing rate this week was up at ~$88.0bbl. The fiscal year-to-date average of $82.5bbl compared to our base case of $85bbl.

We explore the likely macroeconomic impact of higher oil prices on the Indian economy.

Under the CPI basket, fuel and light have a 6.8% weight, with transport and communication (T&C) at 8.6%. The direct and indirect impact of every $10pb move in the oil prices on headline CPI could be to the tune of 30-40bp gain assuming passthrough, with a bigger impact on tradable-heavy WPI inflation. This can be amplified further if persistent high transportation costs seep into food and inflationary expectations.

For now, we see a lower scope of spillover to the domestic retail pump prices in an election year, thereby limiting any material change to the inflation trajectory. This excludes a small (less than 0.05%) spillover risk from other non-retail pump prices/ transportation segments. However, earlier reports of a potential fuel price cut look challenging in light of the escalation in global rally in the energy commodity. In the interim, the balance sheets of the domestic state-owned oil marketing companies are likely to be under pressure. With food likely to be a bigger driver than fuel, we maintain our CPI forecast of 5.5% for FY24, holding on to our call for a delayed start in the easing cycle as outlined in India: RBI stays hawkish and nimble, primarily on uncertain global developments.

For the current account, for every $10bbl climb in the oil prices, the deficit as a % of GDP stands to widen by ~35-40bp. As it stands, the anticipated terms of trade benefit from lower commodity prices have not fructified this year, along with lower discounts on the purchases from Russia vs News reports[1], however suggest that discounts had widened in Sep23 after a strong pushback from Indian refiners, with the landed prices of Russian supplies this year ~$7-$15 lower than those from Iraq and Saudi Arabia. We retain our forecast for the current account deficit at -1.5% of GDP, with a move up in oil average at $100bbl likely to push up the CAD by $10-12bn.

On the fiscal end, reforms in the fuel subsidy mechanism had made pump prices more vulnerable to global swings. Nonetheless, retail prices have been held unchanged since last year to relieve pressure on households’ purchasing power. Part of the financial burden is being parked under the OMCs for now and might be compensated towards the year-end. If oil prices stay high, additional subsidies and lower excise collections (if fuel duties are cut) will be necessary. Disbursements under total subsidies stood at 48% of the budgeted target, with the fuel at 33%, nutrient fertilizers at 78% and food at 42% (see chart).

By Apr-Aug23, revenue (recurring) and capex spending are at 37% of the budgeted target. Plans to allocate more funds towards social support akin to the recent cut in cooking gas prices (India: Weather, inflation, growth), (~0.03% of GDP), an extension of the free food scheme, increase in the minimum support prices for farm produce and handouts to boost demand, could ply pressure on this year’s fiscal math.

Tax collections, which started the year on a subdued note, caught up in Aug23, with year-to-date gross tax up a strong 16.5% yoy.

Net tax collections reached 34.5% of the full-year target in the first five months of FY24, driven primarily by strong direct tax receipts. Income tax collections jumped 35.7% yoy in Apr-Aug23, besides corporate taxes up 15.1%. Indirect taxes, including GST (centre’s up 17% yoy) and customs are also expected to gather momentum, whilst excise collections might miss the mark narrowly, particularly if rates are cut to provide relief on the fuel front.

While strong tax revenues are a tailwind, spending needs might also grow if inflation stays high and the farm incomes are hurt by adverse weather conditions ahead of key state and general elections. But any resultant strain on the fiscal balance is likely to be addressed by reallocation amongst the spending heads (on higher opex demand) rather than a material slippage in the budget metrics.

The key risk to our benign view rests on the oil price action. If the conflict expands to more oil-producing countries with far-reaching consequences, a subsequent squeeze on oil prices will pose a policy dilemma for the economy, not helped by the busy election period ahead.

[1] Business Standard

 
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