The economic damage inflicted by the COVID-19 crisis has forced the government to delay fiscal consolidation and widen the budget deficit in order to spend more and restore the economy to health.
With Russia’s decision to invade Ukraine last month pushing crude oil prices to their highest levels in 14 years, India, which relies heavily on oil imports, will now also see the deficit of its current balance widening, thus posing a significant headwind for the rupee.
As the United States and its European allies mulled a ban on Russian oil imports following Moscow’s invasion of Ukraine last month, international crude oil prices rose to their highest levels since 2008, climbing by more than 6% on Monday.
Brent crude futures rose $8.46, or 7.2%, to $126.57 a barrel at 0128 GMT, while U.S. West Texas Intermediate (WTI) crude rose 7.65 dollars, or 6.6%, to reach 123.33 dollars.
The Indian currency hit a record low of 77.0280 to the dollar on Monday, down from 76.1600/$1 at the previous close.
The current account deficit, which is the net difference between the total value of imports and the total value of exports, has already tightened considerably and this worrying trend is likely to continue, analysts say.
“The merchandise trade deficit widened to $21.2 billion in February from $17.9 billion in January, mainly due to a surge in oil imports and more basic imports. high…rising oil and commodity prices in general, particularly aggravated by Russia’s ongoing conflict in Ukraine, are expected to further increase the import bill in the coming months,” the economists from Nomura.
“We expect the current account deficit to widen to 2.6% of GDP in FY23 (year ending March 2023) from 1.7% of GDP in FY22 , assuming oil prices average $86.6/bbl, so if oil prices continue at current high levels, then risks are skewed towards a much wider deficit.
The sharp rise in the current account deficit, which had been significantly brought under control during the initial stages of the pandemic due to lower demand for imports, is seen as a factor likely to exacerbate the continuing wave of outflows. overseas investments that India is witnessing.
So far in the current calendar year, foreign institutional investors have withdrawn funds worth a massive Rs 83,926 crores from Indian equity and debt markets, with the lion’s share of sales taking place. producing in the country’s stock markets, according to data from the NSDL.
With overseas capital outflows weighing on the rupee, traders fear a vicious circle where further depreciation of the Indian currency could trigger even more overseas selling pressure.
“Every day is a new day. Our forecast is still at $75.50/$1. Given the current environment, there is a risk that the rupiah could end up lower than we had forecast. Every move of a dollar in crude oil prices widens the CAD by about $1.4 billion If there is a 10% increase in crude oil prices, it would entail a 0.2-0.3% widening of GDP in CAD,” said Anubhuti Sahay, Head of Economic Research, South Asia, Standard Chartered Bank.
“We have an estimate of 1.8% of GDP for the CAD next year, but with oil at such levels, the risk is that it will be wider, much wider than what we have now.”
Trust the RBI
Turmoil in global markets may have caused the rupiah to depreciate 3.5% so far in the current calendar year, but market veterans believe India has a strong enough base to weather the storm.
This confidence – a far cry from previous episodes when oil prices soared to such an extent – stems in large part from the sizable war chest of foreign exchange reserves that the RBI has accumulated – $631.53 billion as of February 25. , according to the latest data.
“The RBI has rightly said that the accumulation of foreign exchange reserves is meant to solve this exact problem – overseas outflows, so this is a process that we see taking place,” said Nitin Agarwal, head of of Commerce, ANZ Bank.
Meanwhile, HDFC Bank Chief Economist Abheek Barua believes the market reaction on Monday may have been overdone.
“Today’s reaction may be overstated and in response to the prospect of an embargo on energy supplies from Russia. If this probability decreases, the INR could go back to 76. If the probability remains, we see 77.50 to 78 as the drop in INR,” Barua said.
Another theater where the hardening of crude oil prices will play out is inflation in India and how the RBI chooses to tackle the inevitable upward pressure on consumer prices even as external volatility poses a downside risk to growth.
Although the jury is still out on when the RBI will officially tighten monetary policy, there seems to be a growing consensus that the latest developments could accelerate the central bank’s approach to rate hikes, its forecasts on with inflation likely to be less benign in the April Policy Review.
“The MPC will revise its benign inflation outlook. That’s a given,” said Standard Chartered Bank’s Sahay.
“We maintain our view that by August they will start raising the repo rate as inflation risks have clearly increased and even the RBI in past comments has indicated that higher inflation if it were maintained for longer could have an impact on medium-term growth prospects.”
ANZ Bank’s Agarwal is of the view that in the April review, the RBI is likely to opt for the least harm route by communicating its intention to change the monetary policy stance from neutral to accommodative rather than immediately changing direction and clearing the way for rate hikes at the next review.
“From a rate perspective, we’re seeing what I would call baby steps, because whatever happens will also affect growth,” he said.