The Future of the Indian Rupee Is Tied to Oil Imports

The weakness or strength of the Indian rupee will continue to be largely determined by the level and costs of the country’s 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 strengthened to around Rs. 62 per U.S. dollar, up from a low of Rs. 69 in late August. The trigger for the rupee’s 30% slide against the dollar from May to August, as well as for declines in the currencies of Indonesia, Turkey and some other emerging markets, was fear over their growing balance of trade and current account deficits. For years, financial markets ignored this issue. Then, suddenly, after 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 focus turned to current account deficits in emerging countries.

About 30% of India’s energy needs are met by petroleum. But some 80% of this oil is imported — the major factor behind the country’s ballooning trade and current account deficits. In the fiscal year ending March 2013, India’s 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 five-fold rise in India’s 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 the rupee last summer and led some nervous foreign investors to pull their money out of the country.

India, or for that matter any crude oil importing country, has no control over prices since that is determined by global demand and supply. Low oil prices benefit India while high oil prices are harmful. Domestic consumption rose from 2.9 million bpd in 2008 to 3.1 million bpd in 2009. Yet, in 2009, the cost of oil imports fell to $74 billion, from $106 billion the previous year. So, the hit of net oil imports to India’s balance of trade was lower in 2009. This is because Brent crude prices fell in 2009, averaging around $60 per barrel, down from 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, India’s domestic output of oil climbed four-fold to 800,000 bpd by 1995. Then it stayed flat for the next decade, picking up slightly thereafter. 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-fold to 3.6 million bpd in fiscal year 2013. Even in 1980, just before 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 India’s trade deficit to about 4% of GDP, from under 1% just three years earlier.

A puzzling aspect of India’s oil imports is that domestic refining capacity is four million bpd, 400,000 barrels more than domestic consumption. Most of the recent capacity increase has come from Reliance Industries’ 1.2 million bpd complex in Jamnagar and Essar Oil’s 400,000 bpd plant in Vadinar. These privately owned plants are expected to help reduce imports as well as boost exports of higher-value refined products. But Indian refiners are likely unable to compete in global markets, unless subsidized by the Indian government, against lower-cost producers from the Middle East, especially Qatar, given their far cheaper input costs.

India’s proven crude oil reserves are estimated to be about 5.5 billion barrels, with 53% of it onshore and the rest offshore. That is barely enough to meet domestic consumption over the next four years. Exploration and production of major oil deposits, if any, take decades. The railways and coastal shipping, using India’s long coastline, are both highly energy-efficient 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 difficult prospect since India is also running a budget deficit which was officially 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 benefit farmers, 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 before 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 foreign exchange and containing the current account deficit.

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 for 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 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 deficit, notably taxes on gold imports and sharp cuts in the amount of foreign 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 from tiny amounts three years earlier. Also, with the curbs on exchanging rupees, the unofficial or black market rates for buying dollars and other strong foreign currencies with rupees have risen sharply. With the implementation of these policies, India’s current account deficit has been shrinking slightly as gold imports and foreign currency demand through legal channels have declined. Gold smuggling and black market purchases of foreign currencies do not show up in official balance of payment statistics.

India’s net gold import bill is large: $47 billion in fiscal 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 country’s crude oil imports.

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