Do not celebrate the crash in oil prices. It is a consequence of the growing coronavirus disaster that threatens a deep global recession. In every recession, commodity prices fall. But that indicates coming pain more than gain. Fiscal and monetary policy that used to tackle most recessions may not work this time — the coronavirus does not care a hang about the interest rate or fiscal deficit.
Whether financiers officially label it as such or not, the world is already in recession. We have a double whammy of demand and supply shocks. The epidemic is forcing not just provinces like Hubei, but entire countries like Italy to shut down to contain the disease and even waive mortgage payments despite the blow to its financial sector. Lending will freeze everywhere. This forced inactivity is a huge demand shock — and a supply shock as well, since it restricts production and disrupts global value chains.
China claims the virus is under control, workers are returning to work, and closed factories restarting. But the virus has spread across the globe, even to the US. Everywhere travel, trade, transport, and tourism have crashed. Schools and universities are closing, meetings are being cancelled. Maybe even the Tokyo Olympic Games scheduled for July-August. The medical industry can hardly cope with the flood of new victims.
The oil collapse is a further blow. To combat sustained increases in shale oil production in the US, Opec (Organisation of the Petroleum-Exporting Countries) and Russia last year agreed on production cuts to stabilise oil prices. But then, the virus wrecked oil demand. Opec and Russia could not agree on further production cuts. So, everyone opened up their oil spigots to gain market share. Brent crude has crashed from $65 a barrel a few months ago to just $35.
The shale oil boom in the US requires an oil price of about $50 a barrel for most shale wells to break even. Many producers have struggled to stay afloat recently as the price has drifted down. Last Monday, the US price crashed to $30 a barrel. This created an earthquake on stock markets because of its financial implications.
A huge number of oil companies will go bust if low prices continue. Drilling and associated activity will plunge, and many suppliers will not get paid by collapsing companies. The problem will spread to the banking system with non-performing assets (NPAs) proliferating. The collapse of sectors like travel, transport, retail, entertainment and autos will worsen the slump, bankruptcies and NPAs. The US Federal Reserve will respond with more liquidity and interest rate cuts. But that does not seem remotely enough to check virus-induced paralysis in the economy. Many more cities, states and countries may get locked down in coming months. Europe and Japan have been on the brink of recession and will now fall deep into it.
How long will depressed oil prices last? That depends on the length of the recession, how fast the virus spreads, and how quickly it is controlled. It could take three months, six months or a full year.
Even allowing for some price bounceback, Brent’s average price in 2020 could be closer to $40 a barrel than the forecast $65 a barrel. India’s import bill falls by Rs10,000 crore for every dollar drop in price. If the average price drops $25 a barrel, that implies a windfall of Rs 250,000 crore (1.1 % of GDP) for Indian consumers and the balance of payments. However, remittances from, and exports to, the Gulf will fall substantially.
Alas, this will be more than offset by many negative effects. Tax revenues could fall 10% below budget estimates. The budget hoped for Rs2.15 lakh crore from disinvestment. But the market crash will make it difficult to attain half that much. The sale of Air India looks impossible. Auctions of toll roads, coal mines or railway routes will attract much lower bids.
The revenue drought will mean less money for government investment at a time when private investment has frozen. GoI should mop up half the oil crash windfall through higher taxes to maintain public investment, PM-KISAN and other cash welfare schemes. Even so, GDP growth could plunge below 4%.
The fall in tax revenue will send the fiscal deficit far above budget limits. Finance Minister Nirmala Sitharaman should let that go, but not attempt any further tax cuts as a fiscal stimulus. A fall in revenue is automatically reversed as the economy recovers. But reversing a tax cut is politically difficult and should be avoided.
RBI financed most of the fiscal deficit last year through open market purchases. It should be even more aggressive in the coming year. This will leave ample liquidity in the banks and keep interest rates low.
Other supportive measures are required, like reforms to lower the cost of land, capital, labour, electricity and logistics in India. That apart, social harmony is important for growth, and so the riots in parts of northern India are both morally and economically deplorable. Social media are full of hate messages that should put people in jail. Prime Minister Narendra Modi must forget the Citizenship (Amendment) Act (CAA) and National Register of Citizens (NRC) and focus on healing communal wounds.
