Absence of Iranian oil will hit rupee, CAD and inflation hard. Here’s how

PW Bureau

India’s dependence on Iran to the extent of almost 10 percent of total oil imports means that the immediate challenge is to find alternative suppliers

New Delhi: An increase in fuel prices in the wake of the Unites States’ decision to not grant any more waivers to India or any other country could have an adverse impact on the current account deficit (CAD), the rupee and inflation, a report published by Care Ratings said on Tuesday. The price of oil has started moving upwards in the aftermath of the US decision and can get exacerbated over time.

Where does India import oil from?

In 2018-19, (11 months), the total import of POL was $128.7 billion. The main suppliers were Saudi Arabia, Iraq, UAE and Iran which accounted for a little above 50 percent of the supplies. Iran was the fourth largest supplier of oil to India based on 2018-19 and hence an embargo would mean sourcing the same from other countries which may not provide the same benefits as were provided by Iran in the form of price and credit facility, the report noted.

How will India’s CAD be impacted?

Higher crude oil prices will likely pressurise the trade deficit and current account deficit. As the price of crude oil goes up so do the value of imports as the quantity imported tends to be sticky in general. With the assumption of that other things would remain unchanged, a permanent increase in crude oil prices by 10 percent under ceteris paribus conditions could translate into the current account deficit increasing by 0.4-0.5 percent of GDP, the rating agency said.

What about Rupee?

The currency will be the first point of contact as the trade deficit and current account deficit will widen. FII, FDI etc would need to balance out this deficit or else the balance of payments would be under pressure. The sharp increase in import bill will hence tend to put pressure on the rupee. The rupee will be under pressure on account of both sentiment which will drive the currency in the short run and dollar outflows which will be the natural outcome of higher oil prices. The coefficient of correlation between absolute value of exchange rate and Brent between April 1 and April 22 was high at 0.62. Sustained increase in the price in the range of $70-75/barrel or higher can move the rupee down by 3-4 percent on an annual basis given that the dollar has already started strengthening in the world market.

And inflation?

Care Rating said that the impact on inflation is also significant as it will be driving monetary policy decisions in future. Inflation has been low of late and increasing only gradually due to food and fuel prices moving up. The impact on inflation would depend on two factors: the extent to which crude oil price goes up and the extent to which the government allows the pass through of crude oil price to the consumer. Until the elections are completed, it is unlikely that there will be a full pass through as it will affect voting patterns.

What are the immediate challenges?

India’s dependence on Iran to the extent of almost 10 percent of total oil imports means that the immediate challenge is to find alternative suppliers which will provide crude oil at the same competitive terms. India will have to increase its dependence on oil imports from OPEC nations like Saudi Arabia and United Arab Emirates (UAE). In addition, India may also have to look at US shale gas to stabilize its high oil demand, the report said.