As compared to $65 a barrel, crude oil costing $25 is like a $50 billion bounty for India, claims broking and investment research firm Jefferies India. The government can retain around $30-35 billion of this bounty via higher taxes, opine Mahesh Nandurkar and Abhinav Sinha, both equity analysts at Jefferies India, in an April 24 note.

The analyst duo is of the view that the headroom for the next round of economic stimulus is much higher after the recent decline in the crude oil price, because the current low oil prices offer the government an opportunity to raise taxes on fuels. Nandurkar and Sinha highlight that $10 per barrel in crude can be fully offset if the government raises taxes on auto fuels by around ₹4-5 per litre.

Fuel retail prices in Delhi vs. Brent crude price; Fuel prices have not been reset since March 16
Fuel retail prices in Delhi vs. Brent crude price; Fuel prices have not been reset since March 16
Image : Source: Jefferies India

And, every ₹1 per litre increase in taxes would add close to ₹13,000-14,000 crore (around $2 billion), or 6-7 basis points (bps) of India’s gross domestic product (GDP) to government’s revenues. But, the daily revision in fuel prices by oil majors has stopped since March 16, when fuel duties were raised by ₹3 per litre, and benchmark fuel prices were close to $43 per barrel.

“The crude price decline and a reversion back to normal marketing margins for oil marketing companies would create headroom to raise fuel duties by an additional ₹13 per litre,” Nandurkar and Sinha wrote. “This bakes in Brent at $25 per barrel.”

Crude prices and fuel excise duties; Government has earlier raised duties on fuel as crude prices declined
Crude prices and fuel excise duties; Government has earlier raised duties on fuel as crude prices declined
Image : Source: Jefferies India

The government’s indecision on fuel prices raises concern, in the duo’s view. Given that the government has neither raised taxes in any meaningful way, nor passed on the lower crude prices’ benefits to the retail level, oil marketing companies are making super normal margins. “We estimate that the implied marketing margins are currently about ₹13-14 per litre higher (benchmark $25 per barrel for Brent) than their normal level of ₹3 per litre,” the duo noted.

The government can however unwind these higher margins at any time by raising fuel duties or through fuel price cuts. “This is an easy source for the government to raise fiscal resources for a possible Covid-19 stimulus which is getting delayed,” Nandurkar and Sinha added. “The delay also raises the possibility that the eventual stimulus may be small and disappoint the market,” the duo warns.

While the lower crude prices are positive for India given quantum of its crude imports, the effects from India’s balance of payment (BOP) and exchange rates do have negating effects. With India’s net imports of 1.3 billion barrels of crude oil every year, the analyst duo estimate that every $10 per barrel fall in the Brent oil price lowers India's trade deficit by nearly 40 bps, or 0.4%.

However, the current account deficit (CAD) and BOP impact of the same is not straightforward, given that India is world's largest remittance recipient of close to $80 billion per annum; about 55% of this comes from the Middle East, directly impacted by the sharp decline in crude prices.

Also, sovereign money, often from oil-rich nations, is a major part of India's foreign portfolio investors’ (FPI) portfolio at $41 billion (15% of the total) as of March 2020. “There could be risk of some outflows here,” Nandurkar and Sinha note. “Hence the net impact on the rupee would not be as positive as headline crude decline suggests,” the duo add, as they take comfort from Reserve Bank of India’s (RBI) large forex reserve of $476 billion, which should help mitigate currency volatility.

On the government’s part, while the much anticipated second round of economic stimulus package is delayed, there are spending curbs already in place. Recently, the government announced a freeze on the half-yearly automatic hike of dearness allowance, for 11.5 million employees and pensioners. While the freeze will be in place till 2021, Jefferies India expects a saving of ₹38,000 crore to the exchequer over FY2021-22.

Similarly, the government has also slashed the discretionary spending of the members of Parliament (MPs), and the MPs’ local area development (MPLAD) fund is diverted to Covid-19 fighting efforts. This move, in Jefferies India’s view, would save another ₹7,900 crore over FY2021-22.

Also, the government has ordered expenditure curtailments in the first quarter of the current fiscal, FY2021, whereby government departments are not supposed to spend beyond 15-20% of the budgeted spend of the entire fiscal. Overall, in Nandurkar and Sinha’s views, the government’s decision to cut expenditure in the June quarter, on the contrary, sends a wrong signal.

Amidst the long wait for the second round of the economic stimulus, the sure thing is that the market is anxiously waiting for one.

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