Iran is the fourth largest supplier of oil to India and hence, the removal of 'waiver on the ban of imports' from Tehran is a matter of concern for us. Iran has a share of around 9-10 percent in India's oil imports and hence, it would be essential to rejig the oil basket.
With 2 May just around the corner, it may be expected that the government has already a plan in place given that it was known in November that the waiver was for a period of six months only. During this period, there was no semblance of the talks leading to an acceptable solution for the US. Hence, the ban was more or less a certainty and an extension was not really on the cards.
If India were to continue importing oil from Iran, there was the risk of repercussions from the US in terms of getting different treatment on our exports. The government has already made statements to the extent that other oil producing countries would be tapped for additional supplies. It is not known if countries like China will also change their sourcing pattern or will continue dealing on their terms with Iran. In such a ban, US has the upper hand as all such payments are routed through the American banking system.
US banks will be banned from having any dealings with Iran which could make it difficult to route payments for any importing country. Theoretically, a country can still import from Iran and pay in local currency, but it would invite the wrath of the US on other fronts.
India has had an advantage in importing oil from Iran. First, a part was in rupees which could be used for importing goods from India. This was forex neutral. Second, the credit received by companies was for 90 days unlike 30 days for other countries. Therefore, the importing companies had an advantage here.
Third, the price was reckoned on cost insurance and freight (CIF) basis which meant that the cost was lower than from other countries where the price was reckoned as free-on-board. Therefore, on the whole, the implicit cost of importing from Iran was lower for India.
How will this change now that Iran is out of our trading basket. First, there will be the issue of sourcing oil from other countries. It must be remembered that ever since the Organisation of the Petroleum Exporting Countries (OPEC) decided to cut output in the last meeting post-November to steady prices, supplies have been restricted in the global market.
Therefore, buying oil from other countries could require effort as the requisite nations like Saudi Arabia or UAE should have excess capacity to push up output. Second, the cost factor cannot be escaped as global prices would tend to increase, which is already evident and the marginal edge that we had when we imported from Iran would also get eroded. Therefore, the comfort of lower prices will diminish. It has to be seen in June when the OPEC meets again whether or not oil output will be increase as this affects all nations and not just India.
Higher oil prices would cause reworking of our economic indicators and policy. Higher prices will immediately impact our trade deficit as the value of imports increases. When prices were in the region of $40-$50 per barrel, the share of oil in imports was less than 20 percent which increases to around 30 percent as the price reaches $70 per barrel.
This will automatically tend to pressurise the current account deficit which can move towards 3 percent of the Gross Domestic Product (GDP) mark. This, in turn, will pressurise the rupee, which has already started moving down due to the announcement effect. Hence, the comfort of a strong rupee may be more transient than was expected. Rupee depreciation this year is more certain now.
Higher prices of crude on account of the Iran ban also means that inflation will rise. Here, given the weights of fuel products in the indices, the Wholesale Price Index (WPI) will be more affected than the Consumer Price Index (CPI) as the weight is around 10 percent (direct) compared with around 2.5 percent (direct) for the CPI.
It may, however, be recollected that when the oil prices soared in October 2018 and the currency also moved towards 75 against the dollar, the Reserve Bank of India (RBI) had pointed to the inflation risk in its statement on credit policy and increased the repo rate and took the stance of calibrated tightening. While a similar magnitude of price increase may not be expected this time, the Monetary Policy Committee (MPC) will definitely take this into account while taking up rate cut. It is likely that a rate cut would be deferred till the time there is clarity on the oil economics.
The impact on the government will be mixed. While the subsidy bill will come under pressure as liquid petroleum gas (LPG) and kerosene are regulated and the cost will go up, the revenue side will witness positive impulse especially for the states. As tax rates remain unchanged, the government revenue will increase. Therefore, the fiscal impact can be positive if the subsidy component is reined in.
The ban comes into effect on 2 May, but one can expect the domestic prices to still be controlled until the elections are over after which the price of petrol and diesel will increase. The rest of the story would depend on the speed at which India finds substitutes for the present supply from Iran, the price of global crude and the decision taken by the OPEC and other producers on output. There will be uncertainty for the next couple of months for sure and the markets will be watching closely.
(The writer is chief economist, CARE Ratings)