RISING OIL PRICES MAY SPOIL D-STREET PARTY

The benchmark indices would have registered a third straight session of loss on Thursday, if not for the 4 per cent surge in index heavyweight Reliance Industries (RIL).

Experts, however, say the surge in global crude oil prices and other commodities has started making investors nervous.

Brent Crude has surged more than 60 per cent since November, crossing $61 a barrel for the first time in 13 months. “Rising commodity prices, including crude, is the biggest risk for corporate earnings and markets,” said Amish Shah, India Equity Strategist, Bofa Securities.

While oil and other commodities will likely move lock-in-step with markets in the near term, this could complicate the turf for investors over the longer term.

“The sharp rise in crude is a symptom of global demand recovery. This bodes well for Indian markets. Historically, crude prices and the Nifty tended to be positively correlated. However, this rise in crude oil could be a significant macro negative for the Indian economy. Every $10/bbl rise in oil increases India’s energy import bill by $16 billion (0.5 per cent of GDP), thus increasing the current account deficit, which could decrease disposable income for consumers as fuel prices rise and could hurt inflation. High taxes on fuel may need to be rationalised if crude continues to rise,” added Shah. Many fear oil prices could continue to head north as major oil producers, mainly Saudi Arabia, have vowed to cut production further to boost prices.

“If Brent crude prices sustain over $65-70 a barrel for a few weeks, we will have the first sign of pressure on Indian macros,” said Deepak Jasani, head (retail research), HDFC Securities.

Experts say one of the redeeming features of the Indian fiscal policy has been the government’s ability to collect taxes from petrol and diesel when oil prices fall. This was one of the biggest factors that helped the government reduce its fiscal deficit and ensure that the fiscal situation did not dramatically deteriorate despite the pandemic.

Analysts said it is difficult to raise retail prices from present levels. If prices keep rising and there is some resistance to higher prices, excise will have to be cut.

“If there is any cut in excise and prices rise another 10-15 per cent, the whole fiscal calculation goes for a toss,” said U R Bhat, director, Dalton Capital India. He said the government will have to look for alternatives to recoup the revenue loss.

“Borrowing requirements will rise if they don’t raise taxes, putting pressure on interest rates. Once interest rates start surging, the equity market party will end as interest rates are a key determinant of equity market levels,” Bhat added.

Downstream oil refining and marketing companies will have trouble if prices keep rising. Margins of these entities could face pressure if the government does not cut excise immediately, and these companies could be compelled to absorb some of the increase in cost.

Many companies benefit from low crude oil prices. These are tyre, lubricant, paint, plastic, footwear, refining, transportation, automobile, consumer discretionary and non-discretionary, and aviation firms, who use either crude oil or its derivatives as raw material. Profitability takes a toll owing to higher input costs. This could negatively impact their share prices in the medium term. On the other hand, oil exploration and petrochemical companies could benefit from a rise in oil prices. Analysts point out that a higher import bill constrains capital expenditure.

“Any significant rise in crude prices could lead to a higher import bill, thus constraining the trade balance. The amount of money we spend on infrastructure and other capital expenditure could be hindered,” said Siddhartha Khemka, head (retail research), Motilal Oswal Financial Services.

Analysts said investors need to be cautious about any variable that could play spoilsport when sitting at an all-time high, as the margin of safety is little less.