CRUDE OIL AND ASSOCIATED INFLATION

1. Background

• In a major relief to the Indian economy, Brent crude prices have fallen sharply over the last ten days. 
• If on the one hand, it is a reflection of expectations of a slowdown in global growth which may have its bearing on India’s growth too, on the other it comes as a big respite for India which imports almost 85% of its oil.
• Softening in crude oil prices can ease off a part of the inflation.

2. Falling of crude oil price

• Decline has come despite OPEC’s announcement to cut supply by 100,000 barrels per day in a bid to prop up the prices.
• The recent sharp decline is due to renewed fears of a recession in Europe and a decline in demand from China, which brought in new Covid lockdown measures amid weakening factory activity. 

3. How sliding crude oil prices affect India's Interest

• India imports nearly 85% of its crude requirement and in the year ended March 2022, the oil import bill doubled to $119 billion on account of rising prices. 
• The rise in import bills not only leads to inflation and a rise in current account deficit and fiscal deficit but also weakens the rupee against the dollar and hurts stock market sentiment.
• A rise in crude oil price also has an indirect impact on India as it leads to a rise in edible oil prices, coal prices and also that of fertilizers as they use gas as the feedstock. Gas accounts for 80% of all fertilizer production costs.
• So if a rise in crude oil prices could lead to a much-enhanced import burden, it also leads to a reduction in demand in the economy which hurts growth.
•  It could also lead to a higher fiscal deficit if the government chooses to bear the burden by way of subsidies.
• In that sense, a softening in crude oil prices is a big relief for all stakeholders – the government, the consumers and even the corporations. If oil continues to trade at lower levels, it will result in lower inflation levels, higher disposable incomes and thereby higher economic growth.

4.Decline in prices of Crude and RBI stand to combat inflation

• While inflation has softened from 7.79 to 6.71 and the trajectory is expected to be downwards going forward in line with the decline in crude oil prices and other commodities, it is unlikely that RBI would take a pause.
• Experts say that while the oil marketing companies (OMCs) have been bearing the burden of high oil prices, it will depend upon whether the government and OMCs take steps to bring down the prices for consumers following the fall in global crude oil prices. 
• RBI may go for a rate hike in its forthcoming monetary policy meeting. 

5. How monetary policy influences Inflation

• Monetary policy is a set of actions to control a nation's overall money supply and achieve economic growth.
• Monetary policy strategies include revising interest rates and changing bank reserve requirements.
• Monetary policy is commonly classified as either expansionary or contractionary.
• Expansionary monetary policy is simply a policy which expands (increases) the supply of money, whereas contractionary monetary policy contracts (decreases) the supply of a country's currency.

6. The Crude oil prices and their impact on Debt Markets

• Market participants believe that a revival in demand in the economy will lead to earnings revival for companies over the next couple of quarters.
• If the decline in crude oil prices is positive for the Indian economy and equity markets, investors should invest with a long-term focus; debt investors too should now prepare themselves to lock into high-interest rates as they peak over the next few months. 
• While the 10-year GSec yield is currently trading at around 7.14%, given that the environment continues to remain challenging and RBI could continue to raise rates, the interest rates could rise further.