Mains Article

Crash in oil prices and opportunities for India [Mains Article]

From about $65 a barrel in December 2019, Brent oil price has crashed to about $35 now — a level last seen in early 2016.
By IT's Mains Articles Team
March 16, 2020

Contents

  • Introduction
  • Decline in oil prices
  • Impact of Covid-19
  • State of Indian economy
  • Opportunities for Indian government
  • Conclusion

Crash in oil prices and opportunities for India

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Introduction:

Crude oil, caught in a spiral of demand destruction due to the coronavirus spread and oversupply worries from the unravelling of the OPEC-plus arrangement, has faced a major rout. India’s silver lining came in the form of a failure of the Organization of the Petroleum Exporting Countries and Russia to reach an agreement on oil production cuts, possibly signalling the end of a nearly five decade-long interventions by oil producers in the international market.

Decline in oil prices:

  • Russia declined to cut its oil supply with an intention to compete with the US shale industry, and, consequently, a price war has started as Saudi Arabia plans a big increase in its oil supply.
  • Saudi Arabia, which is the world’s largest oil exporter, has started offering unprecedented discounts in Europe, the Far East and the US to increase its supplies at the cost of other oil producers.
  • An immediate fallout of the Russia-OPEC meeting was a 9% fall in oil prices recently.

Impact of Covid-19:

  • The impact of Covid-19 is being felt on the global demand for oil, too, as a dramatic increase in Covid-19 cases has put further downward pressure on demand for commodities, including oil.
  • Thus, both supply and demand shocks have coalesced to roil the crude oil market.
  • Since the start of the year, oil prices have fallen by about a third.
  • Prices may drop further under the weight of the twin assault of higher supply and lower demand.
  • It is, therefore, not a stretch to expect oil prices over the coming financial year to be lower than they were in the previous two.
  • This has positive implications for India’s economy and policymaking, as it comes at a time when it has embarked on an uncertain and hesitant recovery.

State of Indian economy:

  • The growth slowdown in the last two years has resulted in a precarious fiscal situation because of tax revenue shortfalls.
  • A direct casualty is the ability of the government to spend or meet its fiscal commitments in the form of budgetary transfers to states, payment of dues and compensation for revenue shortfalls to state governments under the goods and services tax (GST) framework.
  • Budgetary constraints combined with the Fiscal Responsibility and Budget Management Act have held the government back from fully offsetting a private sector demand slowdown with its own spending.
  • Low oil prices offer an opportunity to raise some revenue and improve its fiscal balance.

Opportunities for Indian government:

1. Improve fiscal health:

  • As oil prices slide below levels in the previous two years and also below the price of India’s oil basket of $65 per barrel reportedly assumed for 2020-21, there’s an opportunity to pass on about half the benefit of lower global prices to consumers, while the other half can be used to shore up revenue by levying higher excise duty.
  • The Union government did something similar between 2014 and 2016.
  • It can use the low oil prices to improve its fiscal health, and lessen the budget deficit.

2. Clear Dues:

  • The additional tax revenue thus generated through higher excise duty should be used to clear all dues of the central government, whether to private companies, state governments, or others awaiting tax refunds.
  • Putting cash back in the hands of households and small businesses will go a long way in maintaining the growth of domestic demand, besides improving the credibility of the Union government as a trustworthy counter-party.

3. Provide relief to Telcos:

  • The potential excise duty windfall from oil prices could come in handy for the government to provide relief to beleaguered telecom companies.
  • The government will have fiscal leeway to allow a staggered and a longer schedule for the payments they have to make, arising out of the Supreme Court ruling on adjusted gross revenues.
  • The telecom growth story is an important component of the broader India story, and the sector needs an urgent breather to ensure we are adequately prepared for a 5G roll-out, whenever it happens.

4. Recalibration of financial strategies:

  • A slowdown in economic activity, which is inevitable with restrictions placed on mobility and human interaction, will have adverse fiscal implications.
  • Tax collections will decline.
  • So will remittances from Indian workers in the Gulf, if that region is buffeted by oil and virus shocks.
  • Hence, the quantum of the windfall from lower oil prices will need to be constantly re-assessed and fiscal strategies recalibrated.

5. Long term hedging:

  • Even as it should nimbly take advantage of the lower prices now, the government should seriously consider hedging against possible higher oil prices in the medium- to long-term through appropriate instruments available in financial markets.
  • This idea should be extended to hedging against a fall in the rupee relative to the US dollar too.

6. Policy measures:

  • Finally, it may be worthwhile for the government to consider assembling a crack team of former and current bureaucrats, who have proven their mettle in different crises and in different sectors, to advise it on policy measures that should be adopted in these extraordinary times.
  • Much policy innovation and courage, combined with integrity, will be needed for India to emerge stronger from 2020.
  • For the country’s leadership, there isn’t much to lose from breaking free of old policy and behavioural shackles.

Conclusion:

  • Irrespective of the recent price trends, the Centre should persist with measures to reduce the country’s oil dependency over the long run. It should strive to increase use of renewables, and catalyse a shift to electric vehicles. More effort should be put in to ramp up the stagnating domestic oil output. The country’s strategic oil reserves should be increased by making use of attractive buying opportunities in global markets.
[Ref: Bussiness Standard, Live Mint]
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