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Brent at 7-year high: how are economy, markets and investors impacted?

Karunjit Singh and Sandeep Singh look at why crude prices are rising, how it will impact the Indian economy, consumers, investors and the market, and for how long this volatility will continue

Written by Karunjit Singh , Sandeep Singh | Mumbai, New Delhi |
Updated: January 22, 2022 8:19:11 pm
Brent has spiked 8 per cent over the past week, rocking stock markets that were otherwise relatively steady in spite of the third wave of Covid-19 across the country.

Oil prices are at their highest levels since 2014 — Brent crude hit $88.3 per barrel on Thursday, up 27% since December 1, when it was trading at $69.5.

Brent has spiked 8 per cent over the past week, rocking stock markets that were otherwise relatively steady in spite of the third wave of Covid-19 across the country.

Over the last six trading sessions, the benchmark Sensex at the BSE has lost 1,771 points (2.9%) over fresh concerns around inflation, current account deficit, fiscal deficit, and even the currency.

Why is crude rising?

The spike has been driven primarily by fears of supply side disruptions. The attack by Yemen’s Houthis on fuel trucks in Abu Dhabi, in which three people including two Indians were killed, and the tensions between Russia, the world’s second-largest oil producer, and Ukraine have raised concerns. The outage on an Iraq-Turkey pipeline on Wednesday heightened worries.

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There is also concern over the growing imbalance between demand and supply — the former did not see the moderation that was initially expected as the Omicron wave began.

Further, the key oil producing countries have kept supply on a gradually increasing schedule in spite of the sharp increase in global crude prices. Earlier this month, OPEC decided to increase overall daily production by only 400,000 barrels in February, even though its own prediction is for demand to rise by 4.15 million barrels per day in 2022.

How will it impact the Indian economy?

The rise in crude prices poses inflationary, fiscal, and external sector risks. Crude oil-related products have a direct share of over 9% in the WPI basket and, according to a report by Bank of Baroda chief economist Madan Sabnavis, a 10% increase in crude would lead to an increase of around 0.9% in WPI inflation.

“Our baseline forecast for WPI is 11.5-12% for FY22 and 6% in FY23, which might increase by around ~0.9-1% because of increase in crude prices,” says the report.

India imports more than 80% of its oil requirement, but the share of oil imports in its total imports is around 25%. Rising oil prices will impact the current account deficit — the difference between the values of goods and services imported and exported.

“In FY22, the share of oil imports in India’s total imports has increased to 25.8% (Apr-Dec’21) as oil prices inched up. With oil prices on an uptrend again, the oil import bill is likely to swell further. This will have an impact on India’s external position. We estimate that a 10% hike in oil prices will lead to an increase of India’s CAD by US$ 15bn or 0.4% of GDP. This will have a negative impact on INR,” Sabnavis said in his report.

The rise in crude oil prices is also expected to increase the subsidy on LPG and kerosene, pushing up the subsidy bill.

How do high oil prices impact consumers?

High crude oil prices contributed to the increase in petrol and diesel prices that hit record highs across the country in 2021. Pump prices fell in November as the central government cut excise on petrol and diesel by Rs 5 and Rs 10 per litre respectively, and most states followed by cutting Value Added Tax.

Petrol and diesel are currently Rs 95.41 and Rs 86.7 per litre in the national capital. Since the tax cuts in November, oil marketing companies have not revised prices, even as Brent crude fell from about $84.7 per barrel at the beginning of November to under $70 at the beginning of December. Higher crude prices now could result in higher fuel prices for consumers, even though they did not get the full benefit of the fall in crude prices in November and December.

What can be the impact on investor sentiment and markets?

Investor sentiment has taken a beating over the last few days in line with rising crude prices. Foreign portfolio investors who had invested a net of Rs 3,950 crore until January 11, have turned net sellers over the last seven trading sessions, pulling out a net of Rs 12,825 crore from Indian equities, leading to a fall of nearly 3% in the Sensex.

Even domestic institutional investors who invested a net of Rs 6,919 crore between January 1 and 14, have turned cautious, and invested a net of only Rs 239 crore over the last four trading sessions.

The rupee has fallen nearly 1% against the dollar over the last week, and was trading at 74.45 on Thursday.

“While the rise in crude oil prices is a concern for the Indian economy, I think the market is more worried about its impact on US inflation and the subsequent reaction by the Federal Reserve. The Fed may further advance plans to hike interest rates,” Mrinal Singh, CEO and CIO, InCred Asset Management, said.

Fund managers say markets are likely to remain volatile in the near term, and investors should not react to daily news flows in regard to their investments.

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