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Beginners Guide to Crude Oil Basics: Impact of Oil Prices in India Explained

Founder and CEO, Transfin.
Oct 5, 2018 6:59 AM 5 min read

I will explain how India's macroeconomic parameters get impacted when Crude Oil prices rise. This is an extension of my beginners guide to Crude Oil basics, in particular an earlier piece I wrote explaining the different types of Crude Oil and what factors determine Crude Oil prices.


The INR has weakened to 74 vs. the USD (an all-time low). Benchmark indices Sensex and Nifty 50 have lost more than 1,400 pts and 450 pts since Monday i.e. more than a 4% drop in less than a week. While internal factors like loss of faith in financial stocks post IL&FS do play a role, the looming externality lately characterizing the Indian Economy is the result of Crude Oil prices going out-of-control. This experience is relatively fresh, considering we’ve just gone through almost a decade of record low Oil prices and a depressed rate environment in the West.


Well, the tables have now turned on both.


Moving on…to understand how Crude Oil intermingles with our Economy, it is important to first realize that India sources 80% plus of its annual requirement via imports, making us one of the largest buyers of Crude Oil in the world. Being a relatively price inelastic product, such an external dependence makes Oil a key force driving our macroeconomic realities. Second important thing to realize is that a large part of International Crude Oil trading is conducted in USD, the world’s sole reserve currency of choice i.e. if you need to buy a lot of Crude Oil, you would have to sell your currency in exchange for USD.


At a high level, International Crude Oil prices can easily move our:



Let us go through them one-by-one, looking at the Positive and Negative effects of rising Oil on the said metrics…

Current Account Deficit

A current account deficit (CAD) occurs when the value of goods and services the country imports exceeds the value of goods and services it exports. Current account also includes the country’s net income which comes as inward interest and dividends, transfers like foreign aid, remittances etc. LESS outwards interest, dividends, remittances etc.


Negative: With India being a major importer of Crude Oil, it is obvious how rising Oil prices can expand our CAD by increasing the import bill.


Positive: However, this increase gets balanced to some extent by a corresponding rise in petroleum exports (byproducts), as explained below:

India is dependent on imports for its Crude Oil requirements. This Crude Oil is bought by Indian refineries which convert it into usable forms such as petrol and diesel. The same refineries also manufacture various petroleum byproducts which are ‘net’ exported from the country. Therefore, any rise in Crude Oil prices whilst increases the import bill significantly is also responsible for enhancing (in a limited way) our petroleum exports.


Positive: Another positive which can come from rising Crude Oil prices is the increase in inward dollar remittances. Given the high number of Indian migrants working in the Gulf, an increase in rising Crude Oil prices translates into higher wages for the workers, resulting in higher remittances back home. In fact, the World Bank has already projected remittances to India to rise by 4%-5% to $72bn-$73bn, thanks to the Oil price increase.


Overall: However due to the skewed weight of Oil imports within India’s CAD, a rise in International Crude Oil prices net-net widens the deficit, with most experts pegging India’s CAD to 2.5%+ (as percentage of GDP) by end of FY18 vs. 1.9% at end of FY17.


Fiscal Deficit

It is indicative of government’s finances i.e. When government spending (on public services & investments) exceeds government revenues (from taxes etc.). Till 2014, consumers were protected from Crude Oil price volatility with the government subsidizing petrol and diesel. These subsidies ended up as major spending drives expanding the fiscal deficit whenever Oil prices peaked. It is no coincidence that the fiscal deficit hit an all-time low of -6.49% (as percentage of GDP) in FY09 when Crude Oil prices were at their peak hitting c. $140/bbl in Mid CY08. This however has changed from 2010 onwards when India removed petrol, and subsequently diesel subsidies in 2014, decoupling government finances to a certain extent (Kerosene and LPG subsidies continue to date) with Crude Oil price volatility.


Crude Oil and USD vs INR
Crude Oil and USD vs INR 


USD/INR Exchange Rate

As mentioned earlier most International Crude Oil trade in conducted in USD. Rise in Oil prices hence means India needs to sell more INR to buy USD for importing Crude Oil. INR as a result depreciates with respect to USD.


It is no wonder that the Reserve Bank of India’s USD reserves have shrunk by $1.8bn beginning of July 2018 due to a significant increase in Crude Oil prices (forcing the Central Bank to sell USD and stabilize the USD/INR rate). The reserves were at $377bn end of September, $50bn less than all-time high of $426bn seen in April 2018.



Wholesale inflation is directly correlated to International Crude Oil prices i.e. When Crude Oil prices go up, wholesale inflation goes up and vice versa.  


Consumer inflation is a bit more complicated with the government subsidizing certain fuels like Kerosene and LPG. Crude Oil price impact hence is limited to its translation towards auto fuels like petrol and diesel (which are no longer subsidized). Thereby overall consumer inflation is less correlated with Crude Oil prices than before.


In fact we had earlier calculated that adjusting for currency translation effects, International Crude Oil actually went down by -21% since March 2012. Meanwhile, retail selling price of Petrol has gone up by 24% (from INR65 per litre in March 2012 to INR81 per litre at present)! The culprit driving petrol inflation have been Central Excise Duty and VAT comprising roughly 45% of the retail selling price of Petrol. The government’s taxation relief, announced only yesterday, only validates the initial argument I made.


On a closing note, the overhang of Crude Oil prices would most probably drive today’s Monetary Policy Review by the RBI. Despite a low August consumer inflation of 3.69%, the Central Bank would most likely recommend a rate hike considering the expected inflationary effects driven by Oil – a testament to its power as a key externality affecting the Indian Economy.



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