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Saturday, October 23, 2021

Explained: What spike in crude prices means for economy, markets

The rise in crude prices has contributed to petrol and diesel prices hitting all-time highs in India. Prices of petrol and diesel in India are pegged to a 15-day rolling average of the international prices of these fuels.

Written by Sunny Verma , Sandeep Singh | New Delhi |
Updated: October 13, 2021 3:44:12 pm
A surge in crude prices tends to increase India’s expenditure and adversely affects the fiscal deficit. (File Photo)

The recent spike in global crude oil prices above the $80-per-barrel mark led to a dip in key indices in the stock market as concerns rose over the impact on inflation, currency and input cost for companies across sectors. However, as prices eased, indices in India recovered Thursday in line with global markets.

Why are oil prices rising?

Since hitting a low of $16 per barrel on April 22 last year, the price of Brent crude oil has been rising steadily. Since the beginning of the year, it has risen nearly 58% from about $51.8 per barrel to about $81 at close on Wednesday. The rise has been sharp over the last six weeks, from $65 per barrel on August 20. According to analysts, prices are nearing their intermediate top level of $86 per barrel, around which some cooling off is expected even though the broader trend remains rising.

Crude prices have risen sharply in 2021 on the back of a recovery in global demand as the world economy recovers from the pandemic. Supply restrictions maintained by the OPEC+ grouping , too, have kept international oil prices high. So far, these oil-producing economies have signalled only slow production increases, which is leading to a rise in gas prices as well. A shortage of gas in Europe and Asia has boosted demand for oil for power generation.

The rise in crude prices has contributed to petrol and diesel prices hitting all-time highs in India. Prices of petrol and diesel in India are pegged to a 15-day rolling average of the international prices of these fuels. High taxes by the central and state governments too have contributed to retail prices being far higher.

How will this impact stocks and bonds?

While a sharp surge in oil prices can create short-term panic in the equity markets, historical precedents show that equity markets often bottom out alongside a bottoming out of oil prices. When oil futures turned negative last year at the peak of the pandemic, stock markets bottomed out, but since then they have been on a rising spree in line with surging oil prices. Analysts point out that increasing oil prices reflect growing demand in the economy, and equities often deliver more than the expected inflation that the oil surge may lead to. In line with oil, prices of other commodities including coal has been rising sharply. The BSE Basic Materials Index has risen more than three times from a low of 1,761 on April 3, 2020 to 5,725 at Wednesday’s close. This reflects the general view that economic recovery will strengthen going forward.

As for bonds, the situation can get tricky: Any hint of sustained high inflation can result in rising yields and falling bond prices. So, debt investors need to be watchful whether the interest rate cycle is moving upwards in case the central bank tries to contain inflation. If inflation remains transitory and rising oil prices do not lead to a broad-based increase in prices, the monetary policy is expected to remain accommodative, keeping in check the surge in yields. For bonds, central bank policies will play a far greater role than the direct impact of rising oil prices. As for equity investors, they can increase their exposure to upstream oil companies, which benefit from rising prices. In sectors where oil is a major cost component, a negative reaction on returns can be expected.

How does it impact currency and the economy?

Rising crude prices tend to depress the rupee, as India being a major importer of oil needs more dollars to buy the same amount of crude. Winter tends to put pressure on prices in normal times too. Of late, the power shortage in some geographies, especially China, has been caused by supply chain issues regarding coal. This in turn has increased the demand for oil, aggravating the situation.

CARE Ratings Chief Economist Madan Sabnavis said surging prices will lead to expansion in the import bill and a downward pressure on the rupee. “It is expected now that Brent crude can test the $ 90/barrel mark… Intuitively $10/barrel will mean an increase in the import bill by $ 8.2-$ 9.1 billion for this period (October-March). In FY20 the oil bill was $ 130 billion and in FY21 $ 82.4 billion. In the first 6 months of FY22, oil imports were $ 70.5 billion, and hence, assuming a similar quantum would be imported in the second quarter, there would be an increase in the half-yearly bill by 11.6% to 12.9%. This will tend to impact the trade deficit too,” he said.

The rupee has already started slipping and is moving towards the $ 75 per dollar mark. “At this stage this may be a welcome development as it would aid exports, though imported goods will tend to be more expensive. In the short run a range of Rs 75-75.5 per dollar may be expected before clarity descends on OPEC+ action,” Sabnavis said.

How can it hurt inflation, government finances, and the markets?

Crude import accounts for nearly 20% of India’s import bill. The fuel import bill jumped from $8.5 billion for the quarter ended June 2020 to $24.7 billion for the quarter ended June 2021. A rise in prices could lead to a surge in inflation, forcing the RBI to go for liquidity tightening measures followed by rate hikes. Besides its use as a fuel and a key commodity for the transportation sector, oil is a necessary raw material for several industries. An increase in crude prices means an increase in the cost of producing and transporting goods. It thus adds to inflation; economists say an increase of $10/barrel in crude oil prices could raise inflation by 10 basis points.

A surge in crude prices tends to increase India’s expenditure and adversely affects the fiscal deficit. On the other hand, a rise impacts the current account deficit — a measure of value of imported goods and services exceeding the value of those exported, and indicates how much India owes in foreign currency.

Investors with an exposure to equity markets will have to carefully watch the crude price movement. Sectors including refining, lubricants, aviation and tyres are sensitive to oil price movement. As a rise in crude oil prices impact their input raw material cost, their profitability comes under pressure, thereby hurting their share prices.

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