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India: Oil crisis looming large

Despite RBI Governor Dr Y.V. Reddy putting on a brave front on Tuesday saying that the Indian economy is resilient enough to absorb the oil shock, it is now clear that the ogre of petro inflation will adversely impact India’s growth prospects.

The Indian economy’s high oil intensity (2.8 X that of the US) and inordinately heavy reliance on imported crude (71 per cent of total requirement) makes it vulnerable to any external oil shock. CLSA, in its latest report on the oil scenario, suggests that with the onset of winter in the northern hemisphere, and if oil prices sustain at $50 plus per barrel for the rest of the financial year, GDP growth will be eroded by 1.5 ppt and inflation could rise by 4.8 ppt (if the government were to abstain from controlling retail oil prices.

Further if crude prices average $60/bbl in FY06, 3 ppt will be shaved off India's GDP growth and inflation could rise 3.5 ppt due to the direct and indirect effects.

Finance Minister P. Chidambaram is reconciled to the fact that growth prospects will be dampened. In fact, there is every likelihood of a meeting with PetroMin on crude duty rate cuts in the short term, even as Mani Shankar Aiyar builds a consensus on a price hike with the October-end deadline looming large. On Wednesday, he said, "On either 29th or 30th, I am trying to organise a meeting of all Left parties to discuss the issue of a price hike."

Morgan Stanley, however, is more cautious in its projections. It states that while a higher inflation rate is a given, it will sooner than later start affecting liquidity and interest rates, as also the growth outlook. The moot point is that if the government is restricting oil companies from raising prices in order to protect consumers, who is taking the hit?

It is passing the burden on the oil companies both upstream and downstream and also increasing the fiscal burden by way of a reduction in indirect taxes on petro products. Mahesh Vyas, executive director CMIE reckons that the government's management of the oil shock is commendable.Vinay Jaising, oil analyst at Morgan Stanley believes that the subsidy burden in the system on LPG and kerosene alone would be something like $4.5 billion for FY2005. "In the budget, the government has budgeted Rs 35.6 bn as its share of the LPG and kerosene subsidy, implying that the balance would have to be borne by oil companies."

PSUs have lost Rs 3,160 crore this fiscal on selling diesel and petrol below the import cost. Upstream companies benefit from higher prices, the impact on the downstream sector is mixed depending on the degree of pricing power. While refineries are able to pass on higher crude prices, sticky retail prices (capped by implicit governmental control) imply that margins for the integrated refining and marketing companies (for BPCL, HPCL, IOC - the marketing business still contributes 40-60 per cent of total gross margins) will be squeezed.

Government policy measures are also likely to be heavily geared towards the sector - it has already cut tariffs, rationalised excise duties and also shifted some of the losses of downstream players to upstream companies. CLSA's N. Krishnan and Somshankar Sinha reckon that another policy fine-tuning is likely - our estimates factor in a 50 per cent subsidy sharing by ONGC should prices remain at $60/bbl levels.

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