Why the US-Iran stand-off is bad news for India’s economy

The new developments in the Middle East could not have come at a worse time for India. With the economy languishing at a sub-five per cent GDP growth for the past two quarters, and inflation overshooting the five per cent mark, driven by high prices of onion and pulses, the last thing that the country needed was an exterior shock that would make matters worse. The killing of a key Iranian paramilitary leader Major General Qasem Soleimani in an airstrike in Iraq on Friday morning by the US forces has not only brought the Middle East on the brink once again, it has cast a shadow on the economy of hugely oil-dependent countries such as India. Coming just days ahead of the Union budget–in which finance minister Nirmala Sitharaman is expected to announce tax cuts and further sectoral stimulus to kickstart the economy–the Middle East crisis raises serious questions on the impact on India of a fresh escalation in tensions in the region.

To be sure, the fall-out of the US-Iran stand-off was being discussed intensively in the country for nearly a year now. The first major jolt was when the US refused to renew exemptions given to eight countries, including India, from sanctions to put pressure on Iran to curtail its nuclear weapons programme. The US had reimposed the sanctions on Iran’s oil industry and banks in 2018 after President Donald Trump abandoned a nuclear pact that western powers had signed with Tehran in 2015, which allowed Iran relief in return for limiting its nuclear activities, but had exempted India and a few others from it. But with the cessation of the exemptions, India has not been able to import crude oil from Iran, which was its third largest supplier after Iraq and Saudi Arabia, since May last year.

India, the world’s third-biggest oil consumer, meets more than 80 per cent of its crude oil requirements and around 40 per cent of its natural gas needs through imports. Although successive governments have talked about firm measures to boost India’s oil security, the country’s domestic oil and natural gas production have been slowing down in the past few years, making the country even more import-dependent. India imported 207.3 million tonne of crude oil in 2018-19, and 4.5 million barrels a day in the April-November period of calendar year 2019. Moreover, India’s import dependency based on consumption has increased to 84.5 per cent compared to 83.3 per cent a year ago in the same period. The country spent $111.9 billion on oil imports in 2018-19, up from $87.8 billion in the previous fiscal year, according to the oil ministry’s Petroleum Planning and Analysis Cell (PPAC).

However, India came out largely unscathed from the sanctions on Iran. In order to compensate for the loss of crude from Iran, India resorted to importing more from the US and Venezuela, even as it continued its imports from traditional suppliers such as Saudi Arabia and Iraq. In fact, crude imports from the US rose 72 per cent in the five months to September 2019. It is no secret that Indian oil refiners prefer Middle East crude as it comes cheaper, since those countries extend certain waivers on insurance and freight charges (as Iran used to) or a higher credit period to buyers. However, the real concern at that time was the passage of ships through the Strait of Hormuz that lay between the Persian Gulf and the Gulf of Oman and is strategic since it provides the only sea passage from the Persian Gulf to the open ocean. But tensions rose again after drone strikes by Yemen’s Houthi rebels on two key oil installations of Saudi Aramco on September 14 last year, which hurt supplies from the world’s largest crude producer. The showdown that was simmering between the US and Iran escalated after the former accused Iran of being behind the attack, sending Brent crude prices over $63 a barrel.

But in the latest strike by the US, the impact is expected to be greater still. Brent crude was trading at $68.60 a barrel at 9.45 pm (IST) on January 4, up 3.55 per cent from the previous day’s close. According to an analysis by Care Ratings, the impact on the economy is usually felt in terms of trade deficit (the difference in the value of exports and imports), on the markets, Indian basket of crude oil prices and the exchange rate. At the macro level, every dollar increase in prices on a permanent basis would increase the country’s import bill by roughly $1.6 billion (around Rs 11, 482 crore) per annum. Next, the increase in the price of crude oil has a significant impact on inflation as it drives monetary policy decisions. Retail inflation rose to an over three year high of 5.5 per cent in November 2019, breaching the mid-point of the RBI’s monetary policy committee’s medium-term inflation target of four per cent for the second consecutive month, triggered by a rise in prices of food items. Retail food inflation, on the other hand, soared into double digits to 10.1 per cent for November. Crude oil and its products have a weight of 10.4 per cent in the wholesale price index. Therefore, any increase in the price of crude oil would tend to impact the WPI inflation number commensurately, says Care Ratings.

How is this going to impact fuel prices for customers? Petrol prices were at Rs 81 a litre in Mumbai on January 4, while in Delhi it was Rs 75.35 on January 3. Prices of petrol and diesel always react a little late to the rise in crude oil prices as state-run retailers fix fuel prices daily based on a complex algorithm of 15-day average international benchmark rates. Given the trend in oil prices, it is likely that fuel prices will increase in the next few days as well, say experts. Domestic fuel prices are already at a 13-month high, so in the event of a further hike, the government will need to consider slashing taxes on fuel (excise duty by the Centre and value added taxes by the states), which, in turn, can make a dent on its revenues and widen the fiscal deficit.

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