Iraq Crisis: Impact on Indian Economy
- Swati Saxena, Manager - Equity Retail Research, Religare Securities Ltd

Islamist Militant group ISIS has upraised a wide-ranging crisis in war-torn Iraq; where leeway of arriving at normalcy in the near future appears very slim. The article raises the burning question is - "Whether the sectarian violence in Iraq have any impact on the Indian economy?"

India is profoundly dependent on the Middle East to fulfill its oil requirements out of which around 13 per cent is being imported through Iraq only, which makes Iraq the second largest oil exporter for India. India imports nearly 4 million barrels per day (bpd) of crude oil; more than a third of its total import bill -of which more than half a million bpd come from Iraq. The escalating worries from Sunni rebels in Iraq have upraised an alarming state for Indian economy. India, having a partial yet important enslavement on Iraq has already started facing the heat in many ways.

Crude oil prices have increased sharply and pecked 9 months' highest level recently. Such a massive upsurge in prices will increase the import cost, thus putting pressure on subsidies. The Indian government spends approximately USD 24 billion a year on diesel and cooking fuel subsidies, with a one dollar rise in oil price leading to USD 1.3 billion additional burden on the annual subsidy bill, aggravating concerns on the government's fiscal balances. Subsidy grants are assessed quarterly, based on the average oil price in the preceding quarter, which means that the higher expected oil price would increase the subsidy burden in the second half of this fiscal .

Economy Spill-overs
Further, rising crude oil prices would translate into sustained diesel price hikes. Currently, India is buying crude oil at USD 111.25 a barrel (or Rs 6 ,688 per barrel). Increase in crude oil price to USD 120 a barrel, translating into a rupee realisation of Rs 7,200 a barrel, would subsequently result in the diesel price hike of Rs 5 per litre.

Sustained due-North oil prices for few more months would therefore result in a significant negative impact on India's fiscal deficit and economic growth. As per estimates, this would increase the subsidy costs by Rs 200-225 billion in the current fiscal year, raising apprehensions over the achievement of a fiscal deficit target of 4.1 percent of GDP, acceded by the previous government. The newly elected Finance Minister Arun Jaitley not only have to derive the prudent measures to lessen the frightening situation of food inflation but also have to face the risk of swelling import bills .

Albeit, India's Consumer Price Index (CPI) inflation for the month of May eased to 8.3 per cent, still enough to raise eyebrows and the Wholesale Price Index (WPI) inflation came stronger than expected at 6.0 per cent, a five-month high. This of course portrays that inflation remains on the top of the list of priority based concerns in government's kitty. Amid mounting oil prices, government may announce a fuel price hike where a Rs 1/litre increase in diesel price could lead to 0.8-1 percent point rise in retail inflation, again a shattering impact on Indian economy, which is already experiencing a low growth rate since last few years. The consequent impact in terms of higher transport cost puts further pressure on inflation. High inflation may cause a fall in demand and would significantly affect the industrial growth, which in turn may lead to depressing state of facility shutdown and layoffs.

The Indian currency also felt the burn of the escalating Iraq unrest as recently, the rupee touched its lowest level since late April as higher oil prices are straining government finances. The value of rupee is directly proportional to India's Current Account Deficit (CAD). CAD is the amount that India owes in foreign currency to the world. With soaring oil prices, any subsequent rise in import bills would widen the current account gap which may exert a pressure on Indian rupee.

India may not be Affected?
Despite the intensifying Iraq flux, the Reserve Bank of India governor Raghuram Rajan is not too stressed or concerned and stated that as far as the external cues are concerned, India is in a much better position than last year and is well prepared to face such global uncertainties. He further supported his statement by saying that sufficient reserves (thanks to the effective measures timely taken in last one year), comparatively low CAD (from USD 21.8 billion in June 2013 to USD 4.1 billion in December 2013) and increased foreign exchange reserves (from USD 275 billion in August 2013 to USD 312 billion for the week ended June 6, 2014) would underpin the Indian economy.

Another reason why India need not to fear from Iraq's wobbly situation is the fact that most of India's oil pipeline comes from southern Iraq. So far the militants have taken control of Iraq's largest oil refinery in Baiji, northern Iraq, which is a major supplier of oil to Iraq's domestic market and the oilfields in southern Iraq are unaffected. This means, the supply interruption could intensify the scarcity of electricity and availability of gasoline in Iraq only. However, the government is closely monitoring the entire situation to take the speedy measures required, if any. To evade this type of economic jolts from external fronts in a long run; the government has asked energy companies to prepare a contingency plan for oil imports in order to curb the pressure of stoking inflation and disturbing fiscal calculations.

Back on Track
Inspite of dependency on Middle East for oil imports; the economic state of India is more reliant on how the domestic factors will shape up. All eyes are now on the new government's reform measures and policy actions. Even the global investors are keenly observing that whether the new government would be able to deliver the great expectations of putting the Indian economy back on a new growth trajectory.