Oil price shock feels different this time; HSBC views on LPG shortage, other concerns

In a report titled India’s crude reality, HSBC’s Chief India Economist Pranjul Bhandari said uncertainty around oil benchmarks, LPG and natural gas stocks, along with a possible El Nino, is exacerbating India's concerns. She said the ongoing supply-led disruptions in oil are likely to be more of a growth shock than a price shock until pump prices are raised. She expects the RBI to maintain policy rate in the April 8 policy review, as she gave views on seven persisting concerns:

Why does the oil price shock feel different this time? 

Varying prices of different oil price benchmarks are creating some uncertainty, but Bhandari believes it is natural gas and LPG unavailability that are at the heart of concerns in India, given high reliance on West Asia supplies, low strategic reserves, and the recent doubling of cooking gas connections, bringing the shock closer to home. 

"We calculate a 25 per cent supply shortfall in natural gas, which could shave off 25 basis points (bps) from annual GDP growth if it lasts a full quarter," Bhandari sai.

Is it more a growth or a price shock? 

At present, the majority of the oil price burden is being borne by the public sector, i.e. the oil PSUs. For now, it is more a growth shock than a price shock, since most pump prices are supressed. But if the oil shock lingers, and pump prices are raised, say after April state elections, the private sector would partake more evenly in burden-sharing, though inflation could rise, Bhandari said in the note.

Will consumers or corporates suffer more?

Bhandari said corporates tend to split the cost of higher oil prices between lower profits and higher consumer prices in a 40:60 ratio. Consumers bear a double sting – higher pump prices and higher non-oil prices passed on by corporates. The overall burden sharing ratio between corporates and consumers is 30:70, she said.

Which variables are coming from a position of strength? 

In descending order, the HSBC's economist outlined four. Oil PSU margins were high and are able to withstand losses for now. Inflation was low and can withstand a moderate oil and weather shock, provided no changes are made in the inflation targeting framework which is undergoing review. Growth has been strong, though led by low commodity prices and normal rains, which are reversing. Lastly, the balance of payment (BoP) has been in deficit for a while. Some forex adequacy metrics need monitoring, she said.

How will various economic variables fare?  

Bhandari outlined sensitivities to various oil prices. The external balance will take an immediate hit, she said. 

"Then comes the growth hit, higher if the public sector is bearing much of the burden. Inflation is set to rise, but could remain below the 6 per cent cap. Finally, allowing pump prices to rise will keep a lid on the fiscal deficit," Bhandari  said.

What can the RBI do? 

Bhandari believes the April 8 meeting will be all about communication to address the anxiety around the oil price shock. She expects the RBI to outline scenarios, sensitivities, and broad tenets of their reaction function. 

"Despite the oil price shock we don't expect rate hikes over the foreseeable future as we believe the RBI will focus on one-year ahead inflation, which may look softer than inflation in the immediate months," she said.

How are asset classes faring in March?

The undervaluation gap in equities has widened sharply as per HSBC's model, though not as much in forex and rates.