Feb 24

Feb 24 Why the oil price rise, due to Russia invading Ukraine, hurts the Indian Economy

An oil rig in Russia. Courtesy Wikimedia Commons

February 24, 2022

By Ignatius Chithelen*

Today, following the Russian invasion of Ukraine, the benchmark Brent crude price rose 9% to around $106 per barrel while the Japan-Korea-Marker price for liquefied natural gas (LNG) rose 12% to $29 per million British thermal units (mmBtu).

Russia has a major influence in the global energy markets. It exports around 7.5 million barrels of oil and petroleum products a day, about 70% of its production, making it the second largest oil exporter after Saudi Arabia. Total global oil consumption is about 101 million barrels a day.

Russia also exports about half its natural gas production. It exports oil and gas mainly to Europe. The gas exports, of around 11 billion cubic feet a day, are sent to Europe via three pipelines, including one which passes through Ukraine. Russia is the world’s largest producer of natural gas and the Russian supply accounts for about a third of Europe’s gas consumption.

Oil and gas prices rose due to fears over disruption of Russian supplies and, given strong demand and limited supply, the possibility that Russia may cut off exports in retaliation against Western sanctions, and European countries may reduce imports from Russia to try and hurt its economy.

Meanwhile, the spike in energy prices is hitting the Indian economy with two, mutually reinforcing, blows: a sharp rise in foreign trade deficit and a drop in the value of the Rupee.

India consumes roughly five million barrels of crude oil and 175 million cubic feet (MCF) of natural gas a day. It imports nearly 9 out of 10 barrels of oil and about half of the gas it consumes: about 4.5 million barrels of oil per day and about 25 million tons of LNG a year. As a result, higher prices mean a larger import bill.

In fiscal year ending March 2021, India spent $62 billion on oil imports and $8 billion on LNG imports. Analysts forecast that in the current fiscal year, given rising prices amidst strong demand, the country’s oil import bill will exceed $120 billion and LNG imports will be over $10 billion.

India exports about 1.3 million barrels of gasoline, diesel, jet fuel and other refined petroleum products a day. These higher value products, estimated to bring in about $48 billion in foreign currency in the current fiscal year, help partly offset the foreign currency drain from oil imports.

In large part due to rising volume and prices of oil and gas imports, India’s foreign trade deficit is expanding sharply. In early January, Kotak Securities, a Mumbai based financial services company, estimated that the country’s trade deficit would be $190 billion for the current fiscal year, about double that in fiscal 2021.

The actual trade deficit in fiscal year 2022 will likely far exceed $200 billion since crude oil prices have risen nearly 50% after the report was published. This recent price spike is due to Russian President Vladimir Putin’s threat to invade Ukraine as well as higher demand and tighter supplies.

A decade ago, in fiscal year 2013, India’s oil imports were 2.6 million barrels per day, at Brent crude prices averaging $110 per barrel. That year the cost of oil imports was $109 billion, a more than five-fold rise over the previous decade. As a result, in fiscal year 2013, India’s imports sharply exceeded its exports, leading to a trade deficit of $196 billion. This in turn led to the current account deficit, which is a combination of the trade deficit and the surplus/deficit on imports and exports of services, to rise to $88 billion, or 4.8% of India’s then $1.8 trillion GDP.

Earlier, for a few years, Western investors ignored India’s rising current account deficit. Then almost overnight, in 2013, they grew fearful and pulled their money out of Rupee related investments. That year, during a short span of four months between May and August, the Indian Rupee fell by 30% to an exchange rate of Rs. 69 for one U.S. dollar. A weakening Rupee makes oil and gas imports more expensive, while also raising the cost of petroleum products for Indian consumers.

Today, the Rupee fell by about 1% to around Rs.75 per U.S. dollar. Perhaps purchases by the Reserve Bank of India kept it from dropping further. Also, there appears to be little worry in global financial markets about India’s rising current account deficit. In fiscal 2022, this deficit is estimated to be around $50 billion, or 1.7% of its $3 trillion GDP.

Indian demand for oil and gas is expected to continue rising in the coming decades. By 2030, demand for natural gas is estimated to more than triple to 550 MCFand oil consumption is estimated to rise by 50% to around 7.2 million barrels. While India has gas reserves which can boost domestic supply to meet part of the rising future demand, it has very limited oil reserves and hence the volume of its oil imports will likely keep rising.

In May 2013, the U.S. Federal Reserve Bank announced that it was likely to soon begin reducing the size of its $85 billion in monthly bond purchases, which meant U.S. interest rates would rise. This triggered the flight of Western investors from India, Turkey and Indonesia. They feared the current account deficits, in those emerging market countries. could balloon as interest rates rose, sharply increasing the risk of default on debt repayments by their governments and companies.

Now the U.S. Fed has reduced its monthly bond purchases and is also expected to raise interest rates next month. Since August 2020, the interest rate on the ten year U.S. treasury bond has quadrupled to around 2%. In the coming years, will the spike in U.S. interest rates, combined with rising current account deficits due to higher volume and prices for India’s oil and gas imports, trigger another collapse in the Indian Rupee?