In focus

What are the risks from power shortages in India?


With global activity rebounding from the Covid crisis, fuel shortages in some of the world’s largest economies are coming to the fore. In China, a reliance on coal and the challenge of net zero have added to economic woes.  

India too is feeling the heat from energy shortages. A mismatch of demand and supply has resulted in coal stocks falling to dangerously low levels. Power plants are now reporting on average only a handful of days worth of the supply of coal.

Coal is still crucial to India’s economy. The fossil fuel makes up about half of the country’s total energy supply and is responsible for 70% of power generation. India needs to quickly boost supply to avoid imminent power shortages, which would have wider ramifications for economic activity.

Lifting coal imports is one solution but will be too painful

About one quarter of India’s coal supply is imported – primarily from major coal exporters Indonesia, Australia and South Africa. Boosting imports would be very painful though. As the chart below illustrates, some coal prices having doubled in the past few months.

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Even with no change in import volumes, higher energy prices are set to weigh on India’s trade balance. As we highlighted in our recent research paper into energy transition, India is a net fuel importer of both coal and wider energy, as the next chart shows. A back of the envelope calculation suggests that a 20% rise in the coal price adds about 0.1 percentage points to the trade deficit. Similarly, a 10% rise in the oil price increases the trade deficit by 0.3 percentage points. This will of course have knock on effects, dragging on the wider current account deficit.

Only a year ago, India briefly recorded a current account surplus – the first in 17 years – as imports were so weak during the height of the coronavirus pandemic. Those days now seem long gone.

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Why India can solve coal shortages domestically

Almost three quarters of India’s coal supply is domestic, and India has over 100 billion tonnes of proven coal reserves. That is almost 150 years worth of supply at current annual production rates. In investor jargon, this is a liquidity and not a solvency problem; India has the required coal reserves, it just needs to mine it. From this perspective, So the country is set to avoid a full-blown balance of payments crisis.

The state owned coal mining company, Coal India, is responsible for most of the domestic supply of coal and is now reported to be ramping up production by about 10% to around 1.9 million tonnes of coal per day. While estimates of power demand vary, this should easily cover  the shortage.

The question is whether India can boost its coal mining quickly enough to meet rising demand. This is likely to go to the wire, and ultimately is a test of India’s operational efficiency. Coal needs to be mined out of the ground, transported across the country and stocks rebuilt.

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What are the implications of potential power shortages?  

Not ramping up supply quickly would result in power outages, and dent economic activity. For example, the industrial sector, which contributes around 25% to GDP, consumes 40% of the electricity generated in India. Meanwhile, agricultural activity, which accounts for 20% of GDP, consumes 18% of total electricity generation.   

On the inflation side, energy price inflation, captured through fuel, light and transport, makes up a relatively high share of the inflation basket relative to wider emerging markets at 15%, and it is already running high at around 10% year-on-year.

Energy inflation had previously been expected to fall from here as previous oil price rises drop out of the annual comparisons of inflation. But higher coal prices and oil prices are now set to push up energy inflation further. Power shortages would have a much larger impact on inflation as wider supply side disruption would impact broader core and food inflation,

What does this mean for policy and investors?

While the coal shortages are likely to be solved domestically, there is still a risk of powers shortages. The authorities are acting quickly and so at this stage, the risks to economic growth seem relatively contained. But higher energy prices are set to hurt the trade and wider current account balance, which is likely to weigh on the rupee).

On the policy side, these stagflationary risks are likely to reiterate the Reserve Bank of India’s policy stance of gradual monetary policy normalisation. Although monetary conditions are still extremely accommodative, the central bank is now seeking to withdraw liquidity and in its latest meeting, announced it would stop its purchases of government bonds through its Government Securities Acquisition Programme (GSAP).

Ultimately, monetary policy has been a tailwind for both government bonds and equities. But it now may be turning into a headwind, as both markets have grown accustomed to ample liquidity.