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knowledge.wharton.upenn.edu http://knowledge.wharton.upenn.edu/article/future-indian-rupee-tied-oil-imports/

Nov 15, 2013 Law and Public Policy Opinion Asia-Pacific India

The Future of the Indian Rupee Is Tied to Oil Imports

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.

The Indian rupee will likely continue weakening over the long term, though in October it s trengthened to

around Rs. 62 per U.S. dollar, up f rom a low of Rs. 69 in late August . The 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 Indones ia, Turkey and

some other emerging markets, was fear over their growing balance of trade and current account deficits.

For years, f inancial markets ignored this issue. Then, 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 deficits in emerging countries.

About 30% of Indias energy needs are met by pet ro leum. But some 80% o f 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 deficit to $196 billion, causing a current account deficit of $88 billion or 4.8% of its $1.8

trillion GDP. It is this data that hurt t he rupee last summer and led some nervous f oreign investors to pull

their money out o f the country.

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India, or f or t hat matter any crude oil import ing country, has no cont rol over prices since that is determined

by global demand and supply. Low oil prices benef it India while high oil prices are harmful. Domest ic

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 o f net o il import s to Indias balance of

trade was lower in 2009. This 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 isdetermined by global demand and supply.

From 1980, Indias domestic output o f oil climbed four- f old to 800,000 bpd by 1995. Then it s tayed f lat f or

the next decade, picking up slightly thereaf ter. Last year, it reached 990,000 barrels 780,000 barrels o f

crude oil and the rest natural gas and ot her 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 bo os t automobile sales were implemented, and when oil import s were 458,000 bpd, the

oil import cost o f US$6.7 billion enlarged Indias t rade def icit t o about 4% of GDP, f rom under 1% just three

years earlier.

A puzzling aspect of Indias oil imports is t hat domest ic ref ining capacity is f our million bpd, 400,000 barrels

more than domest ic consumption. Most of the recent capacity increase has come from Reliance Industries

1.2 million bpd complex in Jamnagar and Essar Oils 400,000 bpd plant in Vadinar. These 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 subs idized by t he Indian government,

against lower-cost producers from the Middle East, especially Qatar, given their far cheaper input costs.

Indias proven crude oil reserves are est imated to be about 5.5 billion barrels, with 53% of it onshore and

the rest o f f shore. That is barely enough to meet domest ic consumption over the next f our years.

Explorat ion and production of major o il depos its, if any, take decades. The railways and coastal shipping,

using Indias long coastline, are both highly energy-efficient transportation alternatives that will sharply

reduce oil import s. But to do this, as well as develop other major sources of energy like so lar and nuclear

plants, the Indian government will have to spend hundreds of billions of dollars, a difficult prospect since

India is also running a budget def icit which was o f 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 o f petroleum products need to beaggressively implemented. But the Indian government spends an est imated US$25 billion a year to subs idize

the purchase of diesel, kerosene and other petro leum products t hat benefit f armers, truck transport

operators and car and o ther automobile owners. Last year, there were 2.7 million cars so ld in India plus

800,000 commercial vehicles and 13.8 million two-wheelers, such as scoot ers and moto rcycles. In 1980,

when Rs. 10 (around 17 U.S. cents now) bought a do llar and befo re Maruti Suzuki cars reached the market

in 1983, only 47,000 cars and 79,000 t rucks, buses and vans were sold. Automobile policies unt il 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.

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Now, in addition to cancelling petroleum subsidies, there is need for punitive taxes to curb use of petroleum

products, as is the case in some European countries. But bo th are unlikely to happen given the political

backlash from the beneficiaries 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 o n gold imports and sharp cuts in the amount of f oreign exchange

available to Indian companies and individuals. Due to the t axes, 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 est imatedthat about 200 tons o f the precious metal will be smuggled into India in 2013, up from tiny amount s three

years earlier. Also , with the curbs on exchanging rupees, the unof f icial or black market rates f or buying

dollars and o ther s tro ng f oreign currencies with rupees have risen sharply. With the implementat ion o f

these policies, Indias current account def icit has been shrinking slightly as go ld import s 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 o il import

bill. So the weakness or st rength o f the Indian rupee will continue to be largely determined by the level and

costs of the countrys crude oil imports.