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A framework to

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The Crude Arithmetic of Indian Economy....

Indrajit Mitra
July 20, 2011 ; +91 22 67526639
A Sneak peek
Global crude oil price fluctuations have been a frequent phenomena in the recent past.

With 3.3mn bbl/day (according to the IMF), India is the sixth-largest oil consuming and seventh-largest
oil importing nation in the world.

Hence, each global oil price shock has been followed or preceded by an occurrence prominent to the
Indian economy, with respect to its growth, inflation and fiscal deficit as well as the Indian financial

The study shows how each factor is related to and is likely to be affected by oil price increase or
decrease, taking relevant historical data as reference.

The observations have been made at three given prices at $93/bbl (the implied price), $120/bbl and
$70/bbl of ICOB (Indian Crude Oil Basket).


Every $1/bbl increase in ICOB brings down IIP by ~12bps affecting the industrial output largely, thereby
bringing down GDP growth rate by ~3bps.

Change in $1/bbl of ICOB brings about a directly proportionate change of ~5bps in WPI inflation.

At $120/bbl, the fiscal deficit to touch 5.5% of GDP under Ceteris Paribas.

At $120/bbl, the 10YGS yield may reach to 8.81% and credit off take may be stretched by ~459bps.

The supply-demand dynamics

Source: Energy Information Administration (EIA)

Explaining the Base Case
Govt. Assumptions:
India Fiscal Deficit in FY12 = 4.6% with 14% nominal GDP growth
Oil subsidy in FY12 = $5.05bn assuming USD/INR at 45.5
Other Assumptions:
India daily oil consumption = 3.3mn bbl in FY11; Average vehicle sales growth in India = 3% and Import growth = 17.6% in FY12

Base Case:
Implied Indian crude
oil basket (ICOB) =

IIP Manufacturing to Oil under recovery to be

strike 7.3% y/y growth Our model ~$10.1bn
Given ~79%
weight in IIP WPI Fuel & Power
inflation = 10.6%
Contribution to overall
IIP = 5.8% Given ~14.9%
Assuming~28% Fuel & Power
industry weight weight in WPI
in GDP

Contribution to GDP Contribution to WPI Fiscal deficit = 4.6% of

= 2.0% inflation = 1.6% GDP

At Base Case the implied oil price assumption stands at $93/bbl
The model attempts to integrate established econometric linkages that enable creation of a black box which
offers to adapt its responses flexibly to the inputs

Table 1: Oil price algorithm

FY11 FY12E Assumption/ Remarks
Growth (%) 3.0% India's avg. Vehicle sales growth in FY12
India's daily oil consumption (mn bbl) 3.3 3.4 Daily avg. oil consumption
India's annual oil consunmption(mn bbl) 1,205 1,241
Total oil import bill (USDbn) 98 115 5 yr CAGR (2006-11)=17.6%
India Crude Oil Basket (ICOB) (USD/bbl) 81 93 Tot. oil import bill/Annual oil consumption
Oil Subsidy (USDbn) 8 5.1 As per Budget 2011
Oil subsidy as prop. to total oil import 9.8 5.4 Oil subsidy to drop significantly according to Govt.
Source: Bloomberg, India Budget Document, Almondz Research

Remarks/Assumptions in calculation
The model may struggle to work rationally under extremely turbulent global economic situation

According to IMF, Indias daily average oil consumption = 3.3mn bbl in FY11

The assumption of average vehicle sales growth = 3.0% in FY12

The five-year CAGR (2006-11) of total import bills = 17.6% as FY12 import growth

The budgeted oil subsidy = $5.1bn in FY12 as per India Budget document 2011-12

Scenario analysis
Our model suggests, at Base Case i.e. ICOB = $93/bbl,

IIP manufacturing may strike 7.3% y/y growth, which will contribute 5.8% to overall IIP growth (the weight of IIP-
Manufacturing in overall IIP is ~79%, 1993-94 base) and 2.0 % in GDP growth (as the weight of Industry in overall GDP
is ~28%, 2004-05 base)

The inflation in Fuel & Power group may touch ~10.6% which will add 1.6% to overall WPI inflation (given the weight
of Fuel and Power group in overall WPI is ~14.9%)

We assume that the Govt.s fiscal deficit target remains intact at the base case

Considering the findings, we assess the impact of change in crude prices on growth, inflation and fiscal

To analyze the impact, we create two hypothetical scenarios Scenario-I and Scenario-II. At Scenario-I , we
assume ICOB = $120/bbl and at Scenario-II ICOB = $70/bbl. The findings under these scenarios are
summarized in Table 2, for details please refer the Annexure (Slide12).

Table 2: The impact of oil price

ICOB IIP - Mnfc growth Fuel & Power inflation Fiscal Deficit
($/bbl) YoY % YoY % % to GDP
100% pass-on 50% subsidy sharing
Base Case 93 7.3 10.6 4.6%
Scenerio - I 120 3.2 19.3 5.5%
Scenerio - II 70 10.8 3.2 3.9%
Source: Bloomberg, India Budget Document, Almondz Research

The impact on GDP growth & inflation
The Dated Brent Crude prices were considered for the study, in absence of ICOB given the high correlation
in price movement between them .
Data from April 2006 to September 2008 suggest a negative correlation between crude prices and IIP-
Manufacturing growth with R = 0.77.
The post 2008 financial crisis period was not considered as there were no significant correlation between them

The crude prices and Fuel & Power inflation is related positively (on April 04-May 11 data series)

At Scenario-I, higher oil price will reduce IIP growth by 3.2% which will, in turn, moderate the GDP growth by 1.1%. In
contrast, WPI inflation will increase by 1.3%.
At Scenario-II, lower oil price will increase the IIP growth by 2.8% and, hence, GDP growth by 1.0%, while WPI
inflation will reduce by 1.1%.
Ch 1: Oil Price and IIP manufacturing scatter diagram Ch 2: Brent crude and Fuel & power inflation scatter diagram

Source: Bloomberg, CSO, Almondz Research Source: Bloomberg, Office of Economic Adviser, Almondz Research
At ICOB = $120/bbl, FD to swell to 5.5%
The Fiscal Deficit (FD) is budgeted at $5.05bn in FY12 (assuming 1US$ = `45.5).

We estimated the budgeted FD that will prevail at different crude prices :

FD at *50% of FD at
Incremental Scenario-I
Base Under- / Scenario-
Case recovery II

* Assuming 50% subsidy sharing between Govt. and Upstream/downstream companies

At $93/bbl, fiscal deficit as a percentage to GDP is assumed at 4.6%, under Ceteris Paribas (though most
of the time Ceteris is not Paribas, please excuse bad Latin), according to India Budget document 2011-12

However, at Scenario-I (i.e. ICOB = $ 120/bbl) fiscal deficit is estimated to rise to 5.5% and at Scenario-II
(i.e. ICOB = $ 70/bbl) it will reduce to 3.9% of GDP

Subsidy sharing pattern remains a BLACKBOX
BC = $93/bbl
Scenario-I = $120/bbl
Scenario-II = $70/bbl
Oil Industry

Upstream cos. Midstream cos. Downstream cos.

BC = $10.1bn
Scenario-I = $43.7bn
Scenario-II = $-18.3bn
Subsidy sharing

The magnitude of burden on oil cos.

Up/mid/down-streams and Govt. depends on the subsidy
Govt. Subsidy
burden Estimated oil subsidy
sharing pattern which is still not clear
BC = $5.05bn (% to GDP):
We assume a 50-50 sharing between
Scenario-I = $21.8bn BC = 0.26%
these two counterparts
Scenario-II = $-9.1bn Scenario-I = 1.11%
Scenario-II = no oil subsidy

Scenario-I to stress bank credit off-take by ~459bps
At base case (i.e. ICOB = $93/bbl) we assume RBI will reach targeted credit growth of 19% in FY12.
At Scenario-I, the stress on banking system is estimated at ~459bps i.e. the credit growth overshoots the
RBI target of 19% by ~459bps.
At Scenario-II reduced ICOB would lead to credit growth deteriorating by ~258bps.
The oil price stress on bank credit, in both the cases, may be a significant contributor to liquidity situation
in the money market
The implied under-recovery assumed by finance ministry in its budget arithmetic was pegged at ~$10.1bn
and currently the OMCs are borrowing ~$26.3bn from the banking system. The excess borrowing of
~16.27bn on account of higher oil prices (current ICOB~$103/bbl vs. BC =$93/bbl) is estimated to increase
bank credit by ~215bps.
Fig 1: Credit Market Transmission Channel

Stress on At Scenario-I,
OMCs share of banking stress on Credit Liquidity
under-recovery system: excess growth is scenario
due to price rise
increases credit off-take estimated at worsens
by OMCs ~459bps

Table 3: Oil price sensitivity analysis on Credit Off-take

RBI Target credit Under- Stress on credit Stressed credit Incremental
ICOB off-take recovery offtake growth change
$/bl YoY% $bn $bn YoY% bps
BC 93 19.0 10.1 19.0
Scenario-I 120 19.0 43.7 39.7 23.6 459
Scenario-II 70 19.0 -18.3 -22.3 16.4 -258
Source: Bloomberg, RBI, Almondz Research

At Scenario-I the 10YGS yield to rise by ~91bps
At Scenario-I, Govt. has to borrow $16.8bn more from the market to support the oil subsidy, assuming
other revenue assumptions remain same
To support liquidity deficit more OMOs may come under this scenario
This will put pressure on bond yield and 10YGS yield may rise ~91bps from BC level , which is estimated at
However, under Scenario-II, the 10YGS yield may come down to 7.39%.
The challenge for the Govt., hence, lies in the tussle between these two scenarios to materialize, keeping
other factors constant.
Fig 2: Bond Market Transmission Channel

Excess Govt.
Under-recovery Lower liquidity &
Governments oil borrowing from
increases due to higher
subsidy rises the money
price rise borrowing cost

Table 4: Oil price sensitivity analysis on G-Sect yield

G-Sect Incremental
ICOB Under-recovery Oil subsidy* Excess borrowing Yield change
$/bbl $bn $bn $bn (%) bps
BC 93 10.1 5.1 7.9
Scenario-I 120 43.7 21.9 16.8 8.8 91.0
Scenario-II 70 -18.3 -9.1 -14.2 7.4 -51.0
* Assuming 50% subsidy sharing
Source: Bloomberg, India Budget Document 2011-12, Almondz Research


Table 5: Oil price sensitivity on Growth

Under- IIP-Mnfc Weight in Impact Weight in Impact (+)/(-) (+)/(-)
Oil price recovery growth IIP on IIP GDP on GDP in IIP in GDP
$/bbl $ bn YoY% % % % % % %
BC 93 10.1 7.3 79.0 5.8 28.0 2.0
Scenario-I 120 43.7 3.2 79.0 2.5 28.0 0.9 -3.2 -1.1
Scenario-II 70 -18.3 10.8 79.0 8.5 28.0 3.0 2.8 1.0
Source: Bloomberg, India Budget Document 2011-12, Almondz Research

Table 6: Oil price sensitivity analysis on Inflation

Under- Fuel & Weight in Impact (+)/(-) in
Oil price recovery Power WPI on WPI WPI
$/bbl $ bn YoY% % % %
BC 93 10.1 10.6 14.9% 1.6
Scenario-I 120 43.7 19.3 14.9% 2.9 1.3
Scenario-II 70 -18.3 3.2 14.9% 0.5 -1.1
Source: Bloomberg, India Budget Document 2011-12, Almondz Research

Table 7: Oil price sensitivity analysis on Fiscal Deficit

Under- Fiscal oil Fiscal
Oil price recovery oil subsidy deficit subsidy deficit
$/bbl $ bn `bn `bn % to GDP % to GDP
BC 93 10.1 230 4,128 0.26% 4.6%
Scenario-I 120 43.7 995 4,893 1.11% 5.5%
Scenario-II 70 -18.3 (416) 3,482 -0.46% 3.9%
50% subsidy sharing
USD/INR = 45.5 eop FY12
Nominal GDP growth = 14% in FY12
Oil subsidy at $5.1bn as per India Budget Document 2011-12

Source: Bloomberg, India Budget Document 2011-12, Almondz Research

Thank You

This Document has been prepared by Almondz Global Securities Ltd. The information, analysis and estimates contained herein are based on Almondzs
assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at
best, represents Almondz opinion and is meant for general information only. Almondz, its directors, officers or employees shall not in anyway be responsible for
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*Assisted by Ms. Amena Maredia, as a part of her summer internship assignment