Need to promote energy security to 'oil-proof' Indian economy from adverse geopolitical events: RBI paper

Mumbai (Maharashtra)[India], January 14 : Emphasising deeper understanding of the contagion effects of extreme changes in global crude oil prices on sectoral stock indices for an oil import-dependent economy like India, a RBI working paper has said the "need for oil proofing" the Indian economy - its financial and real sectors - from shocks or adverse geopolitical events cannot be overstated.
The paper lays thrust on the need for a policy for promoting energy security and sustainability.
"This calls for rapid investments in other alternative energy sources for which India has the potential of being self-sustainable. It would also be prudent on the part of regulators to be vigilant of the potential contagion from global crude oil price movements given their wider implications for systemic financial stability," the paper said.
The working paper by the Reserve Bank of India attempts to measure the contagion impact of extreme changes in global crude oil prices on 10 composite sectoral indices of the Indian stock markets.
The paper found strong statistical evidence of the likelihood of contagion effects from extreme changes in global crude oil price getting transmitted to sectoral indices of Indian stock markets.
"Of the two oil exceedances - positive and negative, the contagion effect of positive oil exceedances was not only dominating as indicated by the higher magnitude of the positive coefficients but was seen impacting all 10 sectoral stock indices compared with seven in the case of negative oil exceedances," the paper said. Exceedance is the act or fact of exceeding something, especially a limit or standard.
The findings of the paper, 'Measuring Contagion Effects of Crude Oil Prices on Sectoral Stock Price Indices in India', suggested that there might be other factors prompting a higher and more pervasive contagion on the sectoral stocks in the Indian market, the case in point being the INR/USD market.
The paper used a non-time varying threshold. "Using a time-varying threshold may be an improvement as it would capture the fast-changing dynamics of the global as well as domestic financial and commodity markets; an issue that can be explored in the future work on this subject," the paper said.
The paper, released by RBI on Thursday, examined the asymmetric aspect of the contagion effect on sectoral indices only partially.
"Notwithstanding these limitations, the paper underscores the contagion impact of extreme changes in global crude oil price on Indian sectoral stock indices in a pervasive manner. It also indicated the need for investors in Indian stock markets to hedge their portfolios as a mere diversification of portfolios may not be sufficient to protect their assets from an adverse oil price shock.
"Also, given India's import dependence on crude oil and the observed co-exceedances, any negative stock may lead to a decline in market capitalisation and loss of wealth for investors," the paper said.
"The need for oil-proofing the Indian economy - its financial and real sectors, from shocks or adverse geopolitical events cannot be overstated. This also points to the need for a policy for promoting energy security and sustainability," the report said.
The paper has used the generalised Pareto distribution (GPD) for estimating excess returns or exceedances, defined as deviations - above and below, thresholds.
The multinomial logit model (MNL) framework is then used for determining the probability of contemporaneous exceedances or co-exceedances, occurring the same day for 10 sectoral Indian stocks and global crude oil returns during the period from January 2007 to December 2020.
The literature defines this probability of co-exceedances as contagion effect.