Download - Impact of Falling Crude Oil Prices on Indian Economy

8/10/2019 Impact of Falling Crude Oil Prices on Indian Economy

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December 18, 2014

Impact of falling crude oil prices on Indian Economy

Indias key economic variables as well as markets

are intricately and inversely tied to crude oil

prices. India has the highest oil import share in

total imports (34%) in the world, making it one of

the most affected countries to oil price shocks.

The oil import bill has gone up 6 fold in the last 10

years and has been one of the key factors behind

the deterioration in several macro variables such

as current account balance, fiscal balance and

inflation. Much as India has been at the receiving

end for the last several years on account of oil

and broader commodity basket price inflation,

India is now poised to be one of the leading

beneficiaries on account of fall in prices of these

commodities. The benefit for India is likely to be

felt across many categories in the form of: lower

Inflation, better fiscal balance, smaller current

account deficit, lower policy rates and benefits for

several sectors. We have explored this in greater

detail below.

Led by hopes of an increase in supply of alternate

sources of energy as well as prospects of

weakness in the global economy, international

crude oil prices have been on the decline over the

past several months. By November, the monthly

average cost for the crude barrel imported into

India came down to USD 77.58, a near 27%

decline on annual basis.

Chart 1. Indian crude basket since 2002

Source: PPAC, SBIFM Research

Crude oil prices impacts Indian economy through

multiple channels: (1) Inflation (2) Import Bills and

remittances from Indian workers who work in oil

exporting nations and hence overall current

account balance (3) Input costs of corporates and

hence business investment (4) Fiscal balance as

both centre and states collect taxes from

petroleum products and centre subsidizes the

under-recoveries of Oil Marketing Companies

(OMC).

Current account balance

Weakness in crude price augurs well for Indias

current account balance (CAD), which imports

more than 75% of its crude oil requirement.

Crude oil and petroleum products make up nearly

34% of Indias import bill. With oil being a

relatively price inelastic commodity of the import

basket, fall in crude price has nearly one-on-one

impact on Indias import bill.

India imports nearly 2.7 million barrels of crude

oil and related products per day (net import). So

USD 1/bbl fall in crude would lead to an

approximate saving of USD 1 billion per annum.

Since oil-marketing companies often enter into an

advance contract with global oil-exporting

partners, the impact of crude price changes on

import bill is usually seen with a lag of 2-3

months. We see USD 20bn fall in crude import

bills for 2014-15 and additional USD 14bn fall in

2015-16 (chart below). Given that 4 quarter

rolling sum of CAD stands at USD 23.4bn as of Q2

2014-15, the crude price at USD 70/bbl has the

potential to take Indias current account to

surplus, everything else staying put.

-80

-60

-40

-20

0

2040

60

80

100

0

20

40

60

80

100

120

140

Apr-02

Dec-02

Aug-03

Apr-04

Dec-04

Aug-05

Apr-06

Dec-06

Aug-07

Apr-08

Dec-08

Aug-09

Apr-10

Dec-10

Aug-11

Apr-12

Dec-12

Aug-13

Apr-14

Crude Oil Price Indian Basket (Average Price, USD/bbl)

Crude Oil Price Indian Basket (% y-o-y)- RHS


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Chart 2. Net Crude and Petroleum products

import (in USD bn)

99.0 103.4 102.8

82.167.8

40

50

60

70

80

90

100110

120

2011-12 2012-13 2013-14 2014-15E 2015-16E

Net Crude and Petrooleum products Import (USD bn)

Crude Oil Price Indian Basket (Average Price, USD/bbl)

Source: CMIE, SBIFM Research; NB: Crude price kept at USD

70/bbl for 2015-16

Nevertheless, we still see Indias current account

balance in the negative quadrant. Gold and non-

oil non-gold imports are likely to rise. Further,

reduced oil prices have the potential to reduce

remittances receipts from Indian workers in the

oil-exporting nations (see chart below), thereby

deteriorating the invisible component of the

current account balance. Additionally, rapid

decline in crude prices are indicative of slump inglobal demand which is likely to hit Indian exports

going forward.

Chart 3. Crude Prices vs. Remittances to India

Source: CMIE, RBI, SBIFM Research

Inflation

Lower oil prices moderates inflation directly by

lowering diesel and petrol prices and then

indirectly by reducing the input costs which has asecond-round impact of fall in prices of other

consumer goods and services.

Given the higher share of tradable goods in

wholesale price Index, the impact of lower crude

prices is much higher on WPI Inflation than CPI

Inflation. Lower oil prices directly impacts 8.6% of

the WPI basket and additionally 5% indirectly

through lower price of crude derivatives such as

chemicals. On the other hand, the crude relateditems account for nearly 6% weight in CPI basket.

Impact of crude prices on inflation in India also

depends on the government policy. While the

crude price has fallen nearly 30% since June 2014,

petrol and diesel prices have only fallen by 11%

and 8% respectively during the same period. This

is due to offsetting impact of increased taxes on

diesel and petrol by the government. Moreover,

the other components of CPI such as LPG at 3.1%

weight in CPI basket and kerosene (PDS and

others) at 0.9% are still at government

administered prices and their future trajectory

again depends on government policy.

Chart 4. Petrol and Diesel prices since April 2014

Source: PPAC, SBIFM Research; NB: Prices has been taken as

average prices in key Indian cities


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Chart 5: Falling petrol and diesel prices has

contributed to CPI disinflation

Source: CSO, SBIFM Research; NB: Petrol and diesel has

22.5% share in CPI: transport and communication index

Very broadly, if everything else remains the same,

a 10% decline in crude prices should translate into

a 20 bps direct impact on CPI inflation. There

could be some indirect impact also on food prices

as diesel is a meaningful component of farm input

prices (irrigation and tractors) and freight rates.

Fiscal Account

Lower crude prices increases the marketing

margins of OMCs which gives additional space to

government to raise the excise duties on

petroleum products. Very recently (in December),

the government increased excise duties on diesel

and gasoline (Rs. 2.5/litre and Rs. 3.75/litre

respectively), which is expected to generate

additional tax revenue of Rs. 320 bn on

annualized basis.

Chart 6. Government's excise collection from

diesel and gasoline set to rise

Source: MOPNG, Kotak Institutional Equities estimates

Further, oil subsidies will decline. Every US$10/bbl

drop in crude oil price is likely to result in aboutRs. 100 bn of lower under-recoveries. Assuming a

simple 50-50% share between the government

and the oil companies, the governments share of

oil subsidy could drop to Rs. 150 bn at US$60/bbl

(vs. Rs.440 bn estimated previously assuming the

same 50-50 sharing model). Further, with diesel

being completely deregulated since Nov 2014,

total diesel subsidy (oil companies and

government combined) is expected to fall by

Rs.520bn in 2014-15 and completely wipe out

from next financial year. The expected launch of

modified Direct Benefit Transfer of LPG or DBTL

scheme from January 2015 (on nation-wide basis)

is also expected to lower LPG subsidy bill going

forward (chart below). The following table shows

the range of subsidy under different currency and

oil price assumptions.

Oil Subsidy in Rs. bn

Brent US$/bbl

40 50 60 70 80 90 90

Rs/

$

60

84 180

276

371

467

563

659

6

2

97 19

6

29

5

39

4

49

3

59

2

69

1

6

4

11

0

21

2

31

4

41

6

51

8

62

0

72

2Source: PPAC, Companies, SBIMF Research


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Chart 7: Oil subsidy by Government and Oil

marketing companies (Rs. In Billion)

0

200

400

600

8001,000

1,200

1,400

1,600

1,800

FY2006

FY2007

FY2008

FY2009

FY2010

FY2011

FY2012

FY2013

FY2014

FY2015E

FY2016E

FY2017E

LPG Kerosene Diesel Petrol

Source: PPAC, Companies, SBIFM Research

Falling crude prices also pulls down the cost of

naphtha which is used as an input for urea,

thereby lowering the fertilizer subsidy as well.

From 2015-16 onwards, the oil and fertilizer

subsidy (which makes for 50% of government

subsidy) looks set to reduce drastically.

The contained subsidy bill opens fiscal headroom

to rev up expenditure in more productive

channels. A point to note here however is that

state government revenues may get marginally

impacted as sales tax that the states levy on

petroleum products is directly linked to the price

of oil. A rough estimate of this negative impact

would be in the range of around Rs. 250 bn on an

annualized basis.

GDP growth

Lower oil prices should also provide a positive

impetus to growth as lower inflation typically

increases real disposable income in the hands of

households thereby pushing the consumer

spending as well as savings.

Further improvement in macro fundamentals like

lower CAD and fiscal deficit and moderate

inflation increases the macro space for fiscal and

monetary policy to boost growth (government

can direct the subsidy amount towards ramping

up capital expenditure and the central bank gets

further comfort to reduce policy rate).

Currency and Rates

Lower crude oil import bill coupled with lowerinflation should lead to improvement in the

fundamental value of the rupee. However, as

mentioned earlier, we still expect current account

balance to be in the negative quadrant on

account of lower export growth, higher gold

imports and lower remittances from Indian

workers in the oil exporting nations. In an

environment of strong Dollar globally and RBIs

intention of building up Forex reserves, rupee is

likely to remain under pressure. Hence, whileIndian rupee is likely to outperform most other

emerging market currencies, we maintain our

view that it is likely to depreciate marginally

against the US Dollar and hover in 62-65 range in

this financial year. We have earlier sent out a

separate detailed note on currency.

The benefit of lowered crude prices felt in

inflation and fiscal account will further bolster

RBIs confidence in delivering a policy rate-cut

early next year.


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Implications of lower crude oil prices on various industries

Oil and Gas There are multiple beneficiaries of the reduction in the subsidy, the government, the oil

marketing firms and the upstream firms.

The petroleum value chain would witness

Exploration : Companies with sizeable exposure to exploration activity would be affected interms of lower prices and profitability. Any benefit to these upstream firms is contingent on

the government revising the subsidy sharing mechanism.

Refining: short term inventory losses due to MTM inventory, although in the medium term

benefits of reduction of working capital. GRMs would depend on refining capacity

addition/utilizations.

Petrochem: Marginal inventory losses. Product spreads will be more driven by Petrochem

capacity addition/utilizations.

Oil lubricants: Being consumer facing, in this case lower base oil prices would help margins

expansion subject to rational competition.

Offshore services: Falling crude rates can result in cut in capex. Daily rates for offshore rig to

come under pressure on account of lower demand and large supply headwinds. Also

segments directly linked with oil capex like seamless tubes would come under pressure.

Consumer We expect the sector to benefit significantly in consumer discretionary spending on account

of lower oil prices.

For consumer companies the benefits are in the form of:

Savings in input cost: Inputs linked to crude as % of revenue for FMCG companies range

between 5% to 30%. EBITDA margin for the companies are in the range of 11% to 25%. A

10% fall in crude will result in EBITDA growth of 3% to 23% for our FMCG coverage. Paints,

home adhesives are the immediate beneficiaries.

Savings in freight cost: Freight as a % of revenue for FMCG companies is between 3 to 6%

and for. A 10% fall in crude will result in EBITDA growth of 2% to 6% for our FMCG coverage.

Again companies with high distribution centricity in their business models like biscuits, and

paints would be immediate beneficiaries here.History suggests that in most cases these companies would increase their brand investments

or pass part of these benefits to consumer for enhancing market position. This should limit

the potential EBITDA improvement.

Industrials A shift from oil subsidies to productive investments by the government is positive for the

industrial sector as a whole. They will also be a beneficiary of lower input costs and lower

interest rates.

Companies with direct market exposure to the infrastructure investments value chain

servicing the Middle East would be affected more

Diesel Genset players can benefit from the substitution opportunity due to fall in the fuel

costs.

Construction Construction companies that have exposure to Middle East markets in terms of the currentorder book including oil & gas projects, buildings etc can get impacted in case of stress in

these markets.

Financial

Services

We expect an increase in domestic savings (government, corporate and household) due to

fall in oil prices which will be beneficial for the financial services sector as a whole. Apart

from this, decline in inflation and interest rates augur well for the banking system.

There could be slight negative impact of slower credit growth as banks lending to fund oil

imports would go down.

Improvement in asset quality should benefit CV financiers as the asset start being cash flow


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productive on account of cheaper fuel (15%+ of running costs for the user)

Cement Direct benefit from lower freight costs which are almost 25-30% of the cost structure for

cement companies.

Marginal positive for lower mining costs where diesel is a primary fuel being used in

excavation activity.

Auto Direct demand beneficiary of falling fuel price. Better consumer sentiment and lower

interest rates would further catalyse expansion of the opportunity here.Tyre companies would benefit from lower raw material costs of crude derivatives and

synthetic rubber, which constitute ~30-40% of raw material costs.

Lower fuel prices should prompt use of less efficient vehicles (SUVs, sedans over

hatchbacks). However, historically there doesn't seem to be any direct correlation.

Telecom Cost of diesel comprises 4-5% of sales for Indian telecom operators, mainly to service the

tower infrastructure. Hence, EBITDA margin improves by 45 bps for every 10% fall in the

price of diesel while absolute EBITDA grows by ~1.5%.

Airlines Fuel costs are 40-50% of revenues and 40-50% of opex (excluding leases). Direct benefits to

the operators.

IT There is no first order impact of fall in crude price. Indirect flow through benefits possible in

travel expense (air fare) which amounts to 2.5-3% of sales, the pass-through of fall in crudeto actual air fare is not directly measureable.

Media There is no meaningful impact of fall in crude on broadcasters, newspapers or distribution

companies.

Others Companies that possess direct exposure, subsidiaries or operations to countries affected

adversely with fall in crude prices or witnessing sharp currency depreciations (like Russia,

Nigeria) would be affected adversely.

This presentation is for information purposes only and is not an offer to sell or a solicitation to buy any mutual fundunits/securities. These views alone are not sufficient and should not be used for the development or implementation of aninvestment strategy. It should not be construed as investment advice to any party. In the preparation of this material, SBIFunds Management Private Limited (the AMC) has used information that is publically available/information researched in-house/ outsourced from various sources. Information gathered and material used in this document is believed to be from

reliable sources. The AMC however, does not warrant the accuracy, reasonableness and/or completeness of anyinformation All opinions and estimates included here constitute our view as of this date and are subject to change withoutnotice. Neither SBI Funds Management Private Limited, nor any person connected with it, accepts any liability arisingfrom the use of this information. The recipient of this material should rely on their investigations and take their ownprofessional advice

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Download - Impact of Falling Crude Oil Prices on Indian Economy

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