If one is asked to draw a list of biggest dangers that the Indian economy is facing, crude oil price volatility will perhaps be among the topmost concerns. With around 80% of dependence on crude oil imports, the fate and health of Indian economy looms largely on global crude prices. On multiple fronts like inflation, rising current account deficit or fiscal deficit, the rising oil prices have been a key threat to domestic economy.
However, things lately have started to take a turn. The oil prices have been softening and rupee has been firming up. This is definitely a reason to cheer from the broader economic perspective for its positive implications on the import bill. Following the reforms that the Indian Government has announced for the energy sector, it is likely that the fuel subsidy bill will be reduced to half. It is important to note here that the key fuels like diesel, kerosene and liquefied petroleum gas are not sold at market prices.
The under recoveries that oil marketing companies incur on the sales of such fuels are fully or partially compensated by the Government (in the form of cash subsidies) and upstream oil companies. Hence, the impact of reforms like phased deregulation of diesel and cap on the number of LPG cylinders along with a decline in crude prices will cut down the under recoveries. For oil marketing companies that receive Government compensation after considerable time lag, this means a huge relief. Easing crude prices will bring down the under recoveries and let oil companies cut down their borrowings (meant for working capital requirements) and interest expenses.
However, the fundamental problems that the domestic energy sector is facing are far from over. The key fuels are not being sold at market prices. There is no clarity regarding subsidy sharing mechanism (distribution of under recovery losses between the Government, upstream and downstream companies). Even if overall under recoveries come down, the energy sector might not be able to enjoy full benefit in case the burden of upstream companies and state run oil marketing companies goes up. It is worth mentioning here that the upstream segment in the past has witnessed its subsidy burden going up from 33% to 40%. The chances that it will be go further up cannot be ruled out.
Hence, while a decline in oil prices is positive for the Indian economy and the overall sector, the need to bring further reforms in the latter cannot be overstated. A correction in oil prices would lower operational cost for sector; however, we are still vulnerable to the volatility in oil prices and exchange rates. For long term energy security, we need to be self sufficient. This can only be ensured by bringing in more investment in the sector in terms of technology and capital which in turn will depend on further reforms in the sector. We hope that with short term relief on account of the fall in oil prices, the Government will not lose sight of the bigger picture and that the reform momentum will continue.