Investment Shastra

Lower Oil Prices: The Inflection Point?

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As you might be observing, oil prices have fallen over the past three months. Recently Goldman Sachs has slashed its 2015 Brent oil price forecasts to $85 per barrel for March 2015.

Talking about the Indian Subcontinent, the prime beneficiary to this event is the Government of India which can meet its fiscal deficit targets comfortably. Since diesel subsidies form a major portion of the government’s annual budget, reduction in oil prices will cut down expenditures. Taking advantage of lower oil prices, the Government has proactively deregulated diesel prices. Although this decision was long pending, we need to see if this deregulation continues with increase in oil prices too. Another benefit would be the decline in inflation which has been the main agenda of the NDA during the general elections.

With expected cut down in fiscal expenditure pertaining to subsidies, there is a good opportunity for the Government to invest into infrastructure projects which are long starving for funds. Lower fiscal deficit and softer diesel prices will help RBI in achieving its inflation targets. This would allow it to back the Government on reforms and investment by cutting interest rates.

Though these are highly positive developments for the economy, the Government has to address numerous other agendas. The Centre has not yet sent out a clear message or guidelines for FDI in retail and exports. The Centre has only started to articulate its vision of manufacturing in India and easing the regulatory and legal policy for businesses. Also, the state level complacency and disagreement on implementation of many such reforms are big hurdles which will dampen the effort taken at the centre.

Looking at the current fundamentals, we just see the locus of high inflation shifting from higher fuel prices to supply bottlenecks and slow moving reforms. We expect inflation to remain at moderate to high levels till the implementation of reforms improves macro fundamentals.

While few domestic industries are welcoming lower oil prices, the export-oriented industries are seeing this event as a caution. If the decline in oil prices is due to slowdown in the global economy, we think exporters will have a tough time selling their products abroad. Even if exports do not contribute majorly to the government’s revenues, their contribution in foreign funds is significant, which is needed to keep current account deficit in check. Even a minor outflow of foreign exchange will depreciate rupee, which may impact private investment in infrastructure and manufacturing.

However, this wouldn’t be a major worry if the decline in oil prices is due to excess supply or due to shift of the consumption to other energy resources or disagreement within the OPEC. Only time will tell the likely reason for decline in oil prices. For details you can also read this Bloomberg article on ‘Why Oil Prices Went Down So Far So Fast

The Government has ample of time in hand to encourage investments in the economy. This will not only attract foreign investment but will also lead to higher GDP growth rate.

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