3 reasons why the fall in crude oil prices may not be good news for India

The 30 per cent drop in Brent oil prices on Monday to $30 a barrel may not be good news for the economy, said analysts at Morgan Stanley, who believe the gains will remain capped due to the overall weakness in the economy given the coronavirus-related health scare.

The decline in oil prices, they believe, will negatively impact the capex outlook for oil related sectors as well as oil producing countries. That apart, credit markets in the US as well as for emerging market (EM) oil producers will likely react negatively, leading to a further tightening of financial conditions.

“Indeed, we are reminded of the episode between mid-2014 to early 2016, when oil prices declined significantly, and led to the widening of corporate credit spreads, which impacted the high yield credit space due to its sector composition,” wrote Chetan Ahya, chief economist and global head of economics at Morgan Stanley in a recent co-authored note with Derrick Y Kam, Nora Wassermann and Frank Zhao, their economists.

Usually, a fall in oil prices is followed with a cut in retail prices of auto fuels and the government passes on the benefit to consumers. However, Morgan Stanley believes gains this time around will remain capped.

“While lower oil prices will translate to lower retail prices, this positive benefit will not be fully realised as the lower oil burden on consumers will likely not fully translate into higher spending in the near term as it is occurring against a backdrop of overall downdraft in the economy and financial market volatility,” the Morgan Stanley report said.

Policy response

The fall in oil prices comes at a time when the global economy is already reeling under the impact of coronavirus, which has dented demand across sectors and economies. Most economists have revised their forecast for global growth in this backdrop, but do expect things to stabilise from the second quarter of 2020 (Q2-20).

Those at Morgan Stanley, for instance, expect global growth to dip to 2.3 per cent in H1-20, as coronavirus disrupts near-term economic activity. That said, they expect things to improve in H2-20 with the virus peaking in April/May, as their base case.

“The outbreak has already prompted a policy response, and we expect more easing in the coming months. The global monetary easing cycle will be extended as the Fed delivers 75 basis points (bps) of cuts by 2Q20, while the European Central Bank (ECB) and Bank of Japan (BoJ) temporarily increase asset purchases. The majority of EM central banks will also cut rates further, taking global monetary policy rates to a new all-time low,” they wrote in a recent report.