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The escalating civil war in Iraq sent crude prices to a nine-month high of $115 a dollar on Friday, potentially signaling tough times ahead for India’s economy that has been struggling with high inflation.
Reflecting the danger to the economy from rising oil prices, the 30-share Sensex ended 348 points lower and the 50-share Nifty was down 107 points at 25,228 and 7,542 levels, respectively.
The rupee also witnessed its biggest single-day fall against the US dollar in four-and-a-half months.
With two-thirds of its crude oil requirements being met from imports and with Iraq being its second-largest oil supplier after Saudi Arabia, India is most vulnerable to the situation.
Any increase in crude oil prices has a direct impact on the domestic prices of auto (petrol, diesel) and kitchen fuels (cooking gas and kerosene), thereby stroking inflation and putting pressure on the pockets of the citizens. Alternatively, if the government tries to suppress the impact oil prices on domestic fuel prices, this will mount pressure on the government’s finances as fuel subsidises will go up.
“While it is too early to say anything at this stage but Iraq crisis is being keenly watched as India's crude-oil imports from Iraq are about $20 billion annually and any supply disruptions can have serious implications for us,” a chief of a leading national oil company told HT, seeking anonymity.
“While presently there are no fears, any fresh unrest could push up prices even further,” he added.
Iraq is also the second largest oil producer amongst members of OPEC, the cartel of the world’s largest oil producing nations.
Emerging fears of supply disruptions saw sudden purchase of dollars in local currency market, putting pressure on the otherwise stabilising rupee against the US dollar. Any increase in oil imports increases India’s oil import bill, at a staggering $145 billion a year thereby putting pressure on the country’s current account deficit (CAD).
India’s has managed to rein the CAD—a broad measures of the gap between dollar inflows and outflows-- to less than 2% of GDP in 2013-14 from a record 4.8% in 2012-13.
The unexpected vault in oil prices, however, could push up India’s import payments and the resultant flight of dollar outflow could hurt the CAD. Besides, the surge in demand for dollars to meet import payments could hurt the rupee’s value. On Friday it closed at 59.76, a fall of 51 paise compared to Thursday’s close.
A weak rupee can fan inflation by making imports costlier. India’s retail inflation—a more realistic index as it captures shop-end prices—stood at 8.3% in May.
Markets also felt the impact and Indian shares slumped nearly 1.5%, posting their biggest single-day fall in nearly four and a half months with blue-chips staging a fall on risk aversion.
The International Energy Agency (IEA) sought to play down fears over the possible loss of oil exports from Iraq, saying that supplies did not appear to be at risk for the moment.
"Concerning as the latest events in Iraq may be, they might not for now, if the conflict does not spread further, put additional Iraqi oil supplies immediately at risk," the Paris-based agency said.
The IEA said on Friday that OPEC would need to produce one million barrels per day (bpd) more oil on average in the second half of 2014 to balance the global market, which will see a steep seasonal spike in demand.