Greasing the economy’s wheels?

India is an oil-guzzler: in 2023, it was the third-biggest importer of crude oil (after China and the US). And this dependence on imported crude oil has long been a problem for India.

Whenever crude oil prices rise past $100, the money India spends on importing oil causes its merchandise trade deficit to balloon. However, over the last decade, a stellar rise in net flows from services and remittances has made this ‘oil problem’ more manageable. As can be seen in the table below, even with crude oil at $100 per barrel, services and remittances are mostly able to cover India’s merchandise deficit.

This, however, does not eliminate India’s vulnerability as far as the Balance of Payments (BOP) is concerned. In those years when India has faced an oil shock, foreign inflows have typically come to its aid. Whether it was the $34 billion FCNR (Foreign Currency Non-Resident) deposit scheme in September 2013 or large loan raises in FY13, FY18, and FY19, foreign capital has often played a crucial role in helping India manage potential BOP crises.

The flip side of this is that in those years when India’s financial and capital accounts (which record international capital transfers and asset flows) are unable to cover the deficit in its current account (which records the inflow and outflow of goods and services), a currency threat looms over the country, and the RBI has to step in.

What this means is that if a sharp increase in oil prices were to happen at the same time as large-scale FII sell-offs, then India’s BOP could deteriorate rapidly. In light of this, foreign flows, especially the more volatile FII equity flows, should be viewed not merely as drivers of stock prices but also as key supports for macroeconomic stability.

A major FII sell-off is currently underway, with FII ownership of Indian equities recently hitting a 12-year low. In addition, India’s dependence on crude oil imports rose marginally in 2023-24 (87.7%, up from 87.4% in the previous year). Thus, any unexpected global oil disruptions at this point could have especially painful consequences for the Indian economy.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.