Will Crude Prices, Politics Play Spoilsport For Markets In 2018?

Will Crude Prices, Politics Play Spoilsport For Markets In 2018?

After stellar gains in 2017, Indian equity investors confront two major risks in the new year—rising oil prices that may stoke inflation and force the central bank to raise interest rates, and an adverse outcome for the ruling Bharatiya Janata Party in state elections that could lead to more populist measures such as loan waivers, say analysts.

“Despite our view of a cyclical recovery, we believe there will be nervousness around the adverse impact of higher oil prices on the external sector and upcoming state elections,” Sonal Varma, managing director and chief India economist at Nomura Holdings Inc., said in a note on 7 December.

Prices of Brent crude oil rose 18% in 2017 to $67.02 per barrel in December, a 30-month high. Higher oil prices are likely to widen the fiscal and current account deficits.

India imports more than 70% of its oil requirement and every $10 per barrel change in oil price adds 0.4% of gross domestic product (GDP) to the current account deficit, according to Nomura. The Economic Survey in January had said rising oil prices were a challenge to India’s growth, projecting the economy to grow in the range of 6.75-7.50% in 2017-18.

India risks a slippage in the 2017-18 fiscal deficit, projected at 3.2% of GDP. The deficit had at the end of November touched 112% of the budget estimate for the fiscal year.

Kaushik Das, chief economist at Deutsche Bank AG’s India unit, said global oil prices heading towards $70 per barrel could incrementally add to macro risks, particularly related to fiscal math and inflation, and could result in a slower growth recovery, if the Reserve Bank of India were to hike rates pre-emptively. “If the fiscal targets for this year and next year are not met, the demand-supply dynamic of the bond market may worsen and can potentially add to financial market volatility,” he said in a 11 December report.

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According to Madan Sabnavis, chief economist, Care Ratings Ltd, crude oil and its products have a weight of 10.4% in the wholesale price index (WPI), out of which crude oil and natural gas have a weight of 2.4%. “Therefore, any increase in the price of crude oil would tend to impact the WPI inflation number commensurately. A 10% increase in crude oil prices would lead to around 0.5-0.7% increase in the WPI directly.”

Politics will likely take centre stage next year as the ruling Bharatiya Janata Party gears up for Lok Sabha elections in 2019. Eight states—Karnataka, Chhattisgarh, Madhya Pradesh, Rajasthan, Meghalaya, Nagaland, Tripura and Mizoram—are to hold assembly elections in 2018.

As the 2019 general election draws closer, state elections are likely to attract greater attention from investors, said Neelkanth Mishra, managing director and India equity strategist at Credit Suisse. “Nearly a fourth of India’s population will experience state polls in the coming 12 months. It is also possible that the general elections could be brought forward to late 2018. This has limited direct economic implications, but the changes in market sentiment may drive volatility,” he said in a report on 14 December.

A heavy political calendar implies multiple event risks as each will be seen, rightly or wrongly, as a referendum on Prime Minister Narendra Modi’s performance, with the focus on the political cycle’s impact on the BJP’s economic policies, said Nomura’s Varma. “A look at past election cycles suggests that central government spending tends to rise in a pre-election year, especially during the four to eight months preceding an election. This was true in 2004, 2009 and 2014, although the rise in 2014 was more modest. Hence, even though the government is likely to tighten its fiscal belt until March, we believe spending is likely to rise sharply from April 2018,” she added.

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According to Bank of America Merrill Lynch, elections in 2019 can drive government policy in 2018 and more loan waivers and cash hand-outs for consumption, especially at the bottom of the income pyramid, are expected. Read More

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