Rising oil prices could take a bite out of India's economy

Key Points
  • Rebounding oil prices have pushed up oil import costs and will widen India's currency account deficit. This will in turn weigh on the rupee, which is expected to depreciate further, economists say.
  • India could overtake China as the world's largest oil demand growth center by 2024, according to a Wood Mackenzie report.
  • Oil prices have shot up this year, and are set to go up further when sanctions on Iran kick in.
A man counts Indian rupee banknotes for a photograph near the Bombay Stock Exchange (BSE) building in Mumbai, India.
Dhiraj Singh | Bloomberg | Getty Images

The Indian economy is in for a rough ride, with rising oil prices set to continue weighing on its already-weakened currency, widen its deficit, and affect its growth outlook.

Rebounding oil prices — and India's unrelenting demand for it — will push up oil imports and widen its current account deficit, which measures the flow of goods, services and investments into and out of the country, economists say.

That widening deficit will result in a weakening rupee, they say, as more imports mean India has to buy more foreign currencies to meet its needs.

"The INR (Indian rupee) is expected to continue to face depreciation pressures during the remainder of 2018, reflecting several factors including further US Fed rate hikes, India's widening current account deficit, and negative global investor sentiment towards emerging markets currencies and assets," IHS Markit Asia-Pacific Chief Economist Rajiv Biswas, said in an email to CNBC.

Biswas predicted that the rupee will depreciate further, falling to 72 rupees against the dollar by the end of 2018 and reaching 74 rupees by August 2019. The rupee was last at 70.16 against the dollar at the close of Monday — representing a 9.96 percent decline since the beginning of this year.

The rupee, along with the Indonesian rupiah and , will continue to be the most vulnerable in Asia, said a ANZ Research note.

India's foreign reserves have been affected by these developments. "A challenging global environment has compelled the Reserve Bank of India (RBI) to intervene aggressively this year to contain rupee depreciation … the drawdown in foreign reserves has been significant," DBS analysts said in a recent note.

Global energy consultancy Wood Mackenzie forecast that India will overtake China as the world's largest oil demand growth center by 2024. According to its report on Monday, demand is expected to grow by 3.5 million barrels per day from 2017 to 2035, accounting for a third of global oil demand growth. That's driven by rising income levels, a growing middle class and increasing need for mobility, the report said.

A widening trade deficit

More expensive oil will lead to a widening trade deficit for India, which is a net importer of oil.

"Due to India's heavy reliance on imported oil and gas, the impact of rising world oil prices has significantly increased the oil import bill. This is the key factor that is driving the deterioration in India's trade position, with July's trade deficit hitting a five year high," said Biswas. Imports grew at a faster pace than exports over 2017 and 2018, he noted.

Oil prices have shot up this year, topping $80 a barrel in May for the first time since 2014. The higher prices were boosted by OPEC-led output cuts and falling Venezuelan and Libyan output, as well as by an imminent drop in Iranian exports as U.S. sanctions return in November this year.

OPEC member Iran has exported around 2.5 million barrels per day (bpd) of crude oil so far this year. Most analysts expect this figure to fall by at least 1 million bpd once sanctions kick in.

Oil set to cost India more

For the rest of 2018 and next year, the oil import bill is expected to increase for India, Asia's third-largest economy.

"The net trade oil deficit has widened considerably, owing to a combination of high oil prices and a weak currency," said DBS economist Radhika Rao. She said that the oil import bill in fiscal year 2019 could spike above $114 billion. Between 2017 and 2018, oil imports were about $88 billion — higher than the previous year's cost of $70 billion.

To counter the drag on growth, India needs to reduce its reliance on oil, but steadily rising consumption in the country is not helping, according to a recent Oxford Economics report.

"Steadily rising per capita consumption has cemented its position as one of the largest oil importers in the world. This keeps the economy exposed to movements in global oil prices," the report said.

It continued: "India needs to lower its oil demand and in turn, imports, to make growth more resilient to higher oil prices. But we think this is unlikely in the next ten years."

The report forecast India's oil demand will increase to 4.4 percent annually in the next decade, compared to 3.7 per year in the last 10 years.

The rising oil imports may also hit India's gross domestic product.

Oxford Economics predicted that oil imports could rise to 5.5 percent by 2030 — from the current 1.4 percent. A 10 percent increase in oil prices can lower the real GDP level by 0.2 percent four quarters later, it added.

— Reuters contributed to this report.