How Crude Oil Prices Impact Indian Market & Economy cover

How Crude Oil Prices Impact Indian Market & Economy?

Understanding how crude oil prices impact Indian market & Indian economy:  The Liquid Gold, as the name goes, is the most important factor in understanding Global economic health. We have seen a 150% fall in the prices of WTI crude oil over a period of the last four months (Feb-May 2020) and a bounce-back of nearly 75%. Therefore, this year has been a year of massive swings in the prices of crude oil.

The price at the beginning of the year was above $60 per barrel and we saw the price of negative (-) $30 per barrel on around 20th April 2020. Hence, in all practical sense, one was paid to buy a barrel of oil. The current price of WTI crude is $35.46 per barrel (1st June 2020). This has caused a crisis in OPEC nations and other countries like Russia, which are dependent on oil exports.

The current price of WTI crude is $35.46 per barrel (1st June 2020)

How Crude Oil Prices Impact Indian Market?

Let us now understand how crude oil prices impact Indian market and its effect on different segments of the economy like current account balance, fiscal deficit, stock market, and more.

1. Impact on Current Account Balance

India imports nearly 84% of its domestic demand and it is one of the largest importers of oil in the world. Indian Oil imports account for nearly 27% of its total imports. Therefore, a fall in the prices of oil will reduce the cost of importing oil from other countries. And this in turn has a direct impact on the current account deficit (the amount that India owes in foreign currency).

Therefore, in the current crisis time (COVID-19 pandemic and economic slowdown), reduced crude oil prices have been a blessing in disguise to the Indian economy. In general, a 5 % increase in oil prices will impact the trade deficit by nearly $4 billion.

2. Impact on Fiscal Deficit

The price of the oil is fixed by the government and it is at a subsidized rate. And then the government compensates the companies for selling the oil at lower prices. These losses are also called under-recoveries. Therefore, the losses incurred because of compensating the companies losses, adds to the Fiscal deficit of India. But with the reduced oil prices, the compensation to be paid to these companies also reduces and which in turn helps in narrowing the fiscal deficit.

3. Impact on Stock Market

Now, if research and history are to be believed, then there is an inverse relationship between the oil price and the Indian equity market. This is because the Indian oil industry is majorly an importer of oil. Therefore, industries like tyre, lubricants, logistics, refinery, airlines, paints, etc are directly affected by a change in oil prices.

Further, as we are aware, energy stocks have nearly 12.5% weightage in Nifty 50 and nearly 15% weightage in Sensex. So, strength in crude oil prices adversely affects these oil-dependent industries and weakness in oil prices, usually signals strength in these companies’ stock prices. If we were to take an example of the paint industry, companies like Asian paints, Kansai Nerolac, etc use oil as a major ingredient in their paint. So, any movement in oil prices directly impacts their performance in the stock market.

Crude Oil Prices Impact on energy index

(Fig: Nifty Energy Index – 10 Yrs Chart)

Crude Oil Prices Impact on energy index (Fig: Crude Oil WTI Futures – 10 Yrs Chart)

Now, if we were to look at the two charts above. The one on the top shows the line graph of the Nifty Energy index for the last ten years and the one at the bottom shows the performance of WTI crude over the period of the last ten years.

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At first glance, it may be very clear that there is an evident negative correlation between the performance of two. During 2011-12, when oil was trading near its peak of $140 per barrel, the Nifty energy index was trading near its low. And, when the Nifty energy index was nearing its peaking in early 2019, the per-barrel cost of crude oil was hovering around $55.

Now, we all must be wondering, that our equity market should have really outperformed when the oil prices crashed to sub-zero levels. But the global pandemic (COVID-19) has slowed down all global economies and we are no exception to it.

4. Impact on Exchange Rate

Rupee, being a free currency (value of rupee depends on the demand in the currency market), its value depends on the current account deficit. Therefore, if the oil prices are high, then the country will have to sell rupees and buy dollars to pay for oil bills. Similarly, if the price of the oil is low, then the current account deficit is low and the amount of dollars required to pay for oil bills are also low.

5. Impact on Inflation

India, being a vast country, the goods need to be transported from one place to another. And oil is a very important catalyst in the movement of vehicles from one place to another. A rise in oil prices leads to a direct increase in the price of goods and services. And it has a direct bearing on the prices of petrol and diesel. And hence it contributes to the rise in inflation in the country.

Therefore, a reduced price of oil comes as a boon to the economy of India. Reports published by and State Bank of India(SBI) suggest that a $10 change in the oil price, impacts inflation by 0.3%.

Closing Thoughts

In conclusion, we can say that weak or reduced oil prices have a major positive impact on the Indian economy. India being an importer of crude oil, so higher oil prices imply, more payment needs to be made in foreign currency. And oil prices have a major say in the financial markets of our country. A weak oil price usually signals strength in the performance of the stock market. And a strong oil price has a negative impact on the performance of the stock market.

And similarly, if we were to take the example of oil-exporting nations, strong oil prices have a very positive effect on their incomes, balance of payments, and their financial markets.

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  • GKS.TEJA says:

    ? very nice and comprehensive article on crude oil and good table of content ?

  • very use full Information…

  • john says:

    Dear Friend , your article has a lot of valid points,
    but to clarify a few misnomers as the following :

    1.)India imports a mix of dubai and brent oil at prices known as the indian crude basket price, which follows the Brent price (bpd) very closely. The negative prices seen of the WTI CO did not really affect the Indian sub continent and its prices.

    2) the drop in Indian basket crude prices as you mentioned does lower the total trade deficit of the nation, due to the lock-down but it also proportionally affects the trade surplus that would have been generated had india had a running economy during those months.

    3)All commodities are the cause of inflation due to productive and scarce nature.As such , in an ideal market situation , the relationship between crude(or any commodity) will be a hyperbolic discounting curve, because as prices increase the prices of the end product increase , but at a stage where precise are too high the government comes into play through subsiding and taxes.
    As such the equity will rise as crude rises to a point.What we see that falls is the currency aka the indian ruppes value drops , because it takes more rupees to buy the same quantity of oil(per barrel) or a share as it did a while back.I the stock\eqity and commodity price is compared with gold or any other commodity, we will see that there has not been such drastic changes.
    Pls note comparing rupees to dollars is a common fallacy many make, but the dollar has also been a weak currency in the last few years (check usdcny or DXY/crb)

    4) The logic behind the comparison between the two charts seem un founded to me.With respect to the nifty energy index the rise can be explained in as the following:
    1.In 2014 one nation one grid one frequency finally implemented and successful; Rural electrification for india became a UN discussion matter and more emphasis made on it.
    2. 2015-2018 saw exports increase widely especially of agricultural products. India gained status of the number one rice exporter in the world.,{petroleum products prime use in transportation fuels-gasoline;diesel;maritime and aviation fuel ; lpg , and naphtha.. Also the largest consumers of natural gas are fertilizer industry and power generation industry.)
    The WTI price drop : A stronger U.S. dollar was one of the principal reasons for plummeting natural gas and oil prices in 2014. Commodities are generally traded in U.S. dollars, which means there is a direct relationship between the dollar and oil prices.

    This is just my POV , and hope not to offend anyone .

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