Brent crude surged nearly 3% on Tuesday and cumulatively gained $5.3 during the last three sessions, to touch $98.23 per barrel, its highest level since September 2014.
A spike in global oil prices, fuelled by the heightened tensions between Russia and the West over Ukraine, could drive up India’s already-elevated wholesale price inflation with spill-over effects on the retail level and bring back fears of a large current account deficit (CAD).
Since brent takes several other commodities, including natural gas and urea, in its stride, the government’s revenue expenditure in FY23 could also turn out to be significantly higher than the budgeted level if oil prices beat the relevant Budget estimate through the year (Economic Survey saw Indian basket of crude to hover around $70-75/barrel through FY23). This is primarily because of a potential big jump in the subsidy on fertiliser from the budgeted level of Rs 1.05 lakh crore, even as decontrol of auto fuels have brought down oil subsidy to modest levels.
Brent crude surged nearly 3% on Tuesday and cumulatively gained $5.3 during the last three sessions, to touch $98.23 per barrel, its highest level since September 2014. Analysts expect volatility to continue in the near term, with “the general bias on the upside” unless the Ukraine tensions aren’t quickly de-escalated.
After a long period of relative comfort, worries had re-emerged on the country’s current account front in the second quarter of the current fiscal when the account ran a deficit of $9.6 billion or 1.3% of the GDP, the largest since Q1 FY20. As a large merchandise trade deficit were witnessed in Q3FY22, the current account deficit in the period is seen to be as much in the whole of FY20. “We expect the current account deficit to widen to a gaping $26-29 billion in Q3FY22, before easing back to $15-17 billion in Q4 FY22,” Aditi Nayar, chief economist at Icra, wrote.
What adds to the worry is that although CAD might have eased in Q4, a much lesser surplus in the capital account in the quarter compared to Q3 might have made financing of CAD tougher. Foreign portfolio investors, who influence the capital account fluctuations, pulled out $6.4 billion from Indian equity and debt markets in Q4. The sell-out by FPIs has continued since, and in January and February so far, net selling was to the tune of $6.7 billion. With the US Fed mulling rate hikes from mid-March, outflows might continue in the short to medium term.
A large capital account surplus — $40 billion — more than offset CAD in Q2FY22. On a balance of payment basis, there was net accretion of a solid $31.2 billion to the forex reserves in the quarter, almost the same level as in the year-ago period, when the current account had a surplus of $15.5 billion.
High global oil prices have a direct and pronounced impact on India’s inflation. Fuel and power inflation in the wholesale price index (WPI) eased to 32.27% in January from as much as 44.37% in November but it still remained way above the headline WPI inflation of 12.96%. The easing in January is because state-run oil marketing companies haven’t hiked prices, apparently because of the assembly elections in key states. But the retail fuel prices could move in tandem with the Indian basket of crude once the polls are concluded.
Retail fuel and light inflation moderated to 9.32% in January from 13.35% in the previous month but still remained above the headline inflation of 6.01%.
The FY22RE for fertiliser subsidy at Rs 1.4 lakh crore, 76% higher than the BE. Till FY20, annual fertiliser subsidy used to be around Rs 80,000 crore, before it shot up to Rs 1.28 lakh crore in FY21 as the government cleared arrears for fertiliser companies in one go.
Sabyasachi Majumdar, Group head and senior V-P, Icra Ratings, said: “Apart from the Ukraine crisis that could impact gas prices directly, the rising crude oil price will have a much bigger impact on the subsidy outlay. That is because three new fertiliser plants at Gorakhpur, Barauni and Sindri are going to start production soon, which will add around 3.8 million tonne (MT) to domestic urea capacity. Ramagundam plant could add 1.27 million tonne (mt) capacity. Each of these plants have contract with gas suppliers, which are linked to the Brent crude prices.” “At the pooled gas price for fertiliser sector at $16/MMBTU announced in December 2021, the subsidy requirement may go up to Rs 1.5 lakh crore for FY23. Pool price could even get closer to $18/MMBTU in FY23 as Brent crude price increase will get reflected on the LNG prices,” Majumdar said.
While DAP, which is mostly imported, is currently hovering around $876/tonne, the imported urea prices have declined by 40% since November to $600/tonne. However, higher LNG prices are seen inflating urea cost—both domestic production and imported. Natural gas accounts for 75-80% of the total cost of production of urea plants in India.
Brent crude was ruling at $89/barrel when budget was presented February 1 and it touched $99/barrel on Tuesday.
Finance secretary TV Somanathan told FE recently that he saw some risks to fertiliser subsidy estimate in the budget, but added that some correction in input prices could mitigate it.
If the government chooses to hold retail prices of decontrolled phosphatic and potassic (P&K) fertilisers including DAP in FY23 as well as it has done in the current fiscal that will also inflate the fertiliser subsidy.
In its latest bimonthly monetary policy review, the RBI projected retail inflation to drop to 4.5% in the next fiscal from 5.3% in FY22. But costlier crude could upset that estimate and may force the RBI to reconsider its accommodative policy stance sooner than anticipated. According to Ravindra Rao, vice-president-Head Commodity Research at Kotak Securities, crude may remain volatile as market players assess risks associated with Russia. “However, the general bias may remain on the upside unless there are serious efforts to de-escalate tensions,” Rao says.
(With inputs from Banikinkar Pattanayak)
