Global oil prices are in a free fall, breaching the psychological barrier of $60 a barrel, triggering a slide in global stock markets and currencies of emerging economies vis-a-vis the US dollar. Cheaper oil is of course good news for India, which imports 80 per cent of its requirements. But its stock market tanked by 500 points last Tuesday and the rupee sank to a 13-month low. India is bound to be affected by international developments, as it is more open to two-way trade and capital flows. But domestic factors are also partly responsible for the stock market correction and weak rupee.
Oil-trading below $60 a barrel hammered energy stocks worldwide and the currencies of emerging market economies that export this commodity like the Russian rouble, Nigerian niara and Brazil’s real. The Indonesian rupiah hit a 16-month low. The rupee has, in fact, declined much less than these currencies against the dollar. The rouble sank like a stone by as much as 11 per cent last Tuesday, its steepest fall since 1998, despite the Russian central bank sharply raising interest rates to defend it. The relentless slide in global crude prices has seriously impaired Russia’s finances.
On the face of it, the global oil price crash appears much steeper than is warranted by demand-supply imbalances. Global demand for oil this year is pegged at 91.4 million barrels per day, while global supply is only just a little more, at 92 million barrels per day, according to the US Energy Information Administration. But oil prices have fallen off the cliff from over $100 per barrel in June to $59 per barrel in mid-December 2014. The reasons for more supply include higher US oil production from shale. America is now the world largest producer, as it overtook Saudi Arabia in the first quarter of this year.
The sharp fall in oil prices have a lot to do with the grim outlook for global economic growth, thanks to major economies experiencing recessions or stagnant growth. China, the largest economy in the world in terms of purchasing power parity, is also slowing down. Not surprisingly, oil demand is expected be much lower, at 90 million barrels a day, in 2015. If global oil supply remains the same as before, the demand-supply mismatch will be much greater at 2 million barrels per day. The upshot is that oil prices might decline in the coming year as well, barring unforeseen developments.
These developments include the possible threat of supply disruption from a major oil producer or rumours to that effect that can result in prices spiking dangerously upwards again. Right now there is excess supply, as oil demand is declining due to weaker global growth. But geopolitical tensions in Libya and Iraq are fast-growing and that can send oil prices spiralling up again. Indian prices are bound to rise in tandem. The inference that global oil prices are only headed downwards is not warranted.
An excess supply situation normally ought to signal to dominant producers like Saudi Arabia or the oil cartel, OPEC, to cut production to avoid a build-up of stock and stabilise prices. But this is exactly what they are choosing not to do, for geopolitical reasons. “Why should we cut production?” asked the Ali Ali-Naimi, Saudi’s oil minister, on the sidelights of the recent climate conference in Lima. The Saudis believe that with oil demand and supply more or less in balance, speculation is largely responsible for the continuing drop in oil prices.
The Saudis and allies like Kuwait and the UAE are doing nothing as falling prices hurt their rivals like Iran much more. The latter is vying for dominance in West Asia. On the other hand, the US is also happy that the sanctions-hit major oil and gas producer Russia suffers in the process. However, the US and Saudis are not on the same side. What the Saudis do not openly admit is that acting to stabilise global oil prices only subsidises shale oil production in the US. There is no doubt that a price below $60 a barrel does adversely affect the economics of oil extraction from shale.
While global cues are responsible for India’s recent stock market behaviour and weaker rupee, domestic factors also have a role to play. The bourses have been on fire ever since the Narendra Modi-led NDA Government took office. Sentiment has been bullish that a government with a commanding majority would implement market-friendly reforms and take the economy to a higher growth trajectory. But this exuberance is at sharp variance with weak economic fundamentals. Industrial output and overall GDP growth are far from reviving. A correction has always been on the cards.
The rupee went down also because India’s trade deficit widened in November. Fragile global economic growth has affected exports while imports have ballooned despite cheaper oil, thanks to gold. These higher imports have to be paid for in dollars, resulting in a weaker rupee. To be sure, the RBI is defending it by resorting to sales of the greenback to keep it in a range of Rs 60-62 to the dollar. For such reasons, the central bank might not be in a terrible hurry to lower interest rates even though wholesale prices have exhibited zero growth of late.
In these volatile times, how much lower will the rupee fall? Factors such as the strength of the dollar and probability of higher US interest rates in 2015 are bound to weigh heavily on its value over the short–term. Narrower interest rate differentials will result in an exodus of portfolio investments from India back to the US. With an outflow of capital, the bearish market sentiment will bear down on the rupee as well. Is this good or bad for the economy? Economic theory states that a weak rupee is good as it boosts exports. But what sort of growth is possible when global economic prospects are sluggish? But much cheaper crude definitely is a major positive for India’s import-dependent economy.
(N Chandra Mohan is an economics and business commentator based in New Delhi)
N Chandra Mohan
