Why Drone Attack on Saudi Aramco's Oil Plant Spells Trouble for the Indian Economy High crude oil prices will compound the slowdown as automobile sector, inflation, current account deficit will be affected

The Indian economy is not in its best shape, and headline numbers provide enough proof. The gross domestic product (GDP) in the first three months of the current financial year has grown at below-than-expected 5%, which as admitted by Reserve Bank of India governor Shaktikanta Das, came as a surprise even for the government.

India's manufacturing growth, as measured by Nikkei Manufacturing Purchasing Managers' Index, declined to 51.4 in August 2019 from 52.5 in July, the weakest since May 2018. To add to the woes, the automobile sector is experiencing one of its worst slumps in the recent history with sales declining in at least the last 13 consecutive months.

If these pain points were not enough for India—till recently one of the fastest growing economies—which prompted finance minister Nirmala Sitharaman to announce a slew of measures to induce growth, came the drone attack on Saudi Aramco's oil facilities at Abqaia and Khurais knocking off 5.7 million barrels per day of crude oil from the world supply; this is 6% of the total global supply.

While Iran, which is under US sanctions and was India's third-largest crude oil supplier till last year, has denied its role in the attacks in Saudi Arabia, Yemen's Houthi group, believed to be aligned to Iran, has claimed responsibility.

Oil price rise and India's inflation

While the direct impact of rising crude oil price would be an increase in petrol, diesel and aviation turbine fuel (ATF) prices, and widening of the current account deficit (CAD) given a heftier crude oil import bill, there are likely to be various domino effects—one event setting off a chain of similar events.

According to Sunil Kumar Sinha, principal economist and director public finance, India Ratings and Research, apart from the direct impact, there could be several indirect or second round impacts that will hurt the economy in case crude oil prices remain elevated.

"Crude oil products are inputs for many industries such as petrochemicals, and all these industries will feel the pinch as input cost will go up," said Sinha, adding that even prices of vegetable and fruits will go up given an expensive diesel would mean higher transportation cost. "This will add to the overall inflation," he said. Crude oil and its products have 10.4 per cent weightage in the Wholesale Price Index compared with 2.8 per cent in Consumer Price Index.

Sinha, however, pointed out that the effect of the first and second of impacts will play out over time, assuming high crude oil prices.

Retail fuel prices in India change every day and are determined by the state-run oil marketing companies (OMCs) Indian Oil Corporation, Bharat Petroleum Corporation and Hindustan Petroleum Corporation. The oil marketers benchmark domestic fuel prices to international product prices, which are dependent on international crude oil prices. The full impact of rise in crude oil prices will take some time to reflect on Indian retail prices as OMCs consider 15-day rolling international product prices.

Finally, an increase in ATF prices will make air travel dearer.

Automobile, currency and deficit

An increase in fuel prices is likely to deter automobile buyers, who are already cautious. While on the one hand there is a push by the government towards electric vehicles, on the other transition from BS IV to BS VI-complaint vehicles by March, 2020 has compounded the uncertainty. Nevertheless, the government has clarified that it will allow BS IV vehicles to run till the end of their life.

Sinha observed that sentiment of consumers is low as they do not see their income growing due to slowdown in the economy, affecting decision to buy automobile. "An increase in running cost (due to higher retail fuel prices) will be another dampener," he said.

Given India imports more than 80 per cent of its crude oil requirement, the import bill will go up significantly in case of high crude oil prices affecting CAD. India imported crude oil worth $112 billion in FY19, according to Petroleum Planning and Analysis Cell.

According to Sinha, if effect of higher oil import bill on CAD is not adequately compensated by inflows, the Indian rupee will depreciate further and make import of other goods expensive, multiplying India's economic challenges.