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The Future of the Indian Rupee Is Tied to Oil Imports

No v 15, 2013 Law and Public Po licy Opinio n Asia-Pacific India

Finance

The weakness or strength of the Indian rupee will continue to be largely determined by the level and costs of the countrys crude oil imports, according to Ignatius Chithelen, managing partner of Banyan Tree Capital Management, a New York-based investment management firm. T he Indian rupee will likely continue weakening over the long term, though in October it strengthened to around Rs. 62 per U.S. dollar, up f rom a low of Rs. 69 in late August. T he trigger f or the rupees 30% slide against the dollar f rom May to August, as well as f or declines in the currencies of Indonesia, Turkey and some other emerging markets, was f ear over their growing balance of trade and current account def icits. For years, f inancial markets ignored this issue. T hen, suddenly, af ter the U.S. Federal Reserve announced in May that it was likely to soon begin reducing the size of its $85 billion monthly bond purchases, the f ocus turned to current account def icits in emerging countries. About 30% of Indias energy needs are met by petroleum. But some 80% of this oil is imported the major f actor behind the countrys ballooning trade and current account def icits. In the f iscal year ending March 2013, Indias net oil import was 2.6 million barrels per day (bpd), at Brent crude prices averaging $110 per barrel. Over the past decade, the more than f ive-f old rise in Indias net oil import bill to $109 billion last year enlarged its trade def icit to $196 billion, causing a current account def icit of $88 billion or 4.8% of its $1.8 trillion GDP. It is this data that hurt the rupee last summer and led some nervous f oreign investors to pull their money out of the country.

India, or f or that matter any crude oil importing country, has no control over prices since that is determined by global demand and supply. Low oil prices benef it India while high oil prices are harmf ul. Domestic consumption rose f rom 2.9 million bpd in 2008 to 3.1 million bpd in 2009. Yet, in 2009, the cost of oil imports f ell to $74 billion, f rom $106 billion the previous year. So, the hit of net oil imports to Indias balance of trade was lower in 2009. T his is because Brent crude prices f ell in 2009, averaging around $60 per barrel, down f rom about $92 the previous year.

India, or for that matter any crude oil importing country, has no control over prices as that is determined by global demand and supply.

From 1980, Indias domestic output of oil climbed f our-f old to 800,000 bpd by 1995. T hen it stayed f lat f or the next decade, picking up slightly thereaf ter. Last year, it reached 990,000 barrels 780,000 barrels of crude oil and the rest natural gas and other liquids. Oil Consumption Gallops Meanwhile, oil consumption since 1980 rose six-f old to 3.6 million bpd in f iscal year 2013. Even in 1980, just bef ore policies to boost automobile sales were implemented, and when oil imports were 458,000 bpd, the oil import cost of US$6.7 billion enlarged Indias trade def icit to about 4% of GDP, f rom under 1% just three years earlier. A puzzling aspect of Indias oil imports is that domestic ref ining capacity is f our million bpd, 400,000 barrels more than domestic consumption. Most of the recent capacity increase has come f rom Reliance Industries 1.2 million bpd complex in Jamnagar and Essar Oils 400,000 bpd plant in Vadinar. T hese privately owned plants are expected to help reduce imports as well as boost exports of higher-value ref ined products. But Indian ref iners are likely unable to compete in global markets, unless subsidized by the Indian government, against lower-cost producers f rom the Middle East, especially Qatar, given their f ar cheaper input costs. Indias proven crude oil reserves are estimated to be about 5.5 billion barrels, with 53% of it onshore and the rest of f shore. T hat is barely enough to meet domestic consumption over the next f our years. Exploration and production of major oil deposits, if any, take decades. T he railways and coastal shipping, using Indias long coastline, are both highly energy-ef f icient transportation alternatives that will sharply reduce oil imports. But to do this, as well as develop other major sources of energy like solar and nuclear plants, the Indian government will have to spend hundreds of billions of dollars, a dif f icult prospect since India is also running a budget def icit which was of f icially put at 5.2% of GDP last year. Petroproducts Subsidy Is Huge So, policies to curb the growth as well as sharply reduce consumption of petroleum products need to be aggressively implemented. But the Indian government spends an estimated US$25 billion a year to subsidize the purchase of diesel, kerosene and other petroleum products that benef it f armers, truck transport operators and car and other automobile owners. Last year, there were 2.7 million cars sold in India plus 800,000 commercial vehicles and 13.8 million two-wheelers, such as scooters and motorcycles. In 1980, when Rs. 10 (around 17 U.S. cents now) bought a dollar and bef ore Maruti Suzuki cars reached the market in 1983, only 47,000 cars and 79,000 trucks, buses and vans were sold. Automobile policies until 1983 were aimed at conserving f oreign exchange and containing the current account def icit.

Besides policies to boost exports, the Indian government has chosen politically easy ways to cut the current account deficit, notably taxes on gold imports.

Now, in addition to cancelling petroleum subsidies, there is need f or punitive taxes to curb use of petroleum products, as is the case in some European countries. But both are unlikely to happen given the political backlash f rom the benef iciaries of the subsidies as well as automakers, distributors and service providers, and employee unions in the auto industry. Besides policies to boost exports, the Indian government has chosen politically easy ways to cut the current account def icit, notably taxes on gold imports and sharp cuts in the amount of f oreign exchange available to Indian companies and individuals. Due to the taxes, gold in India now sells at a $120 plus premium per ounce above the price in Dubai, the largest source of gold smuggling into India. It is estimated that about 200 tons of the precious metal will be smuggled into India in 2013, up f rom tiny amounts three years earlier. Also, with the curbs on exchanging rupees, the unof f icial or black market rates f or buying dollars and other strong f oreign currencies with rupees have risen sharply. With the implementation of these policies, Indias current account def icit has been shrinking slightly as gold imports and f oreign currency demand through legal channels have declined. Gold smuggling and black market purchases of f oreign currencies do not show up in of f icial balance of payment statistics. Indias net gold import bill is large: $47 billion in f iscal year 2013. But that is less than half its net oil import bill. So the weakness or strength of the Indian rupee will continue to be largely determined by the level and costs of the countrys crude oil imports.