Rising Oil Prices and Falling Rupee

- A Double Whammy for Economy!

Media, both the electronic and print, is abuzz with comments that the steady rise in global crude oil prices does not bode well for Indian economy for it could raise costs across the board leading to rise in inflation and fall in corporate profits, besides effecting the investment sentiment even.

To present a better feel about the emerging crisis, let me start at the beginning: Global oil prices remained relatively low right from the middle of 2014 to early 2018—Brent crude falling as low as even $30.34 per barrel in early 2016—perhaps, owing to too much of oil supply in the market resulting from lifting of Iran sanctions as well as the shale boom in the US. Secondly, the deflationary atmosphere that prevailed in the global economy might have also had its contribution for oil prices remaining subdued for quite some time. Nevertheless, this has benefited many oil importing countries. India has indeed witnessed a fall of around 60% in the import bill of oil during 2013-2017.

As against this comfortable scenario, oil prices have been rising since early 2018—Brent crude oil had already crossed $80 per barrel—sending alarm signals across countries such as India that are heavily dependent on imported crude. There are many reasons for this sudden surge in oil prices: one, Saudi Arabia, the country that had earlier refused to cut production has since joined the OPEC cartel in limiting production to nudge prices forward; two, since December, Russia and 10 other non-OPEC countries have joined the cartel in reducing the oil production; three, political turmoil in Venezuela has pulled down its production; and four, the uncertainties resulting from the scrapping of Iran nuclear deal by the US and the resulting reimposition of sanctions has only worsened the scene further.

And, once prices start moving northwards—oil becoming these days more a financial asset—they get subjected to speculative activity. As a result of such price rise and particularly, the volatility thereof, the oil-importing countries like India are facing new challenges: one, it impacts their balance of payment position—a rough estimate indicate for every USD 1 rise in crude oil prices, the influence on the current account deficit will be to the extent of USD 1 billion; two, importantly, there would be inflationary pressure on the economy; three, its reflection on rupee exchange rate; and four, the cumulative effect of all these forces negatively affecting the global investor confidence.

There is already a fall in rupee exchange rate: the US $ worth 63.64 in January rose to 65.64 by April and now it is around 68.02 against dollar. This fall is indeed more than what the correction of overvaluation of rupee that was earlier accused by the exporters, would have required. Such a disorderly fall, though welcomed by the exporters, is certainly not in the interest of the overall economy. For, this could stall the growth, besides stoking inflation.

The simultaneous rise in crude prices and the fall in rupee is indeed complicating the problems of the Indian policy makers. It equally poses a problem to companies for they find it challenging to make investment decisions in such an uncertain scenario of exchange rate movement. Even exporters are no exception to this problem.

Incidentally, the FIIs have already started acting on this changed market scenario: reports indicate that the net foreign portfolio outflows stood at $5 bn. Intriguingly, currency traders feel that the scope for making profit through ‘carry trade’ no longer exists, for the US government bond yields have moved sharply up with the yield on 10-year bond crossing 3%, which means selling assets elsewhere and moving the proceeds to the US bond market for reducing risk. And this whole process is all set to make dollar further strong.

Now the big question for Indian policy makers is: Where rupee settles ultimately? And what needs to be done by the monetary authority? The price of rupee is obviously defined by global interest rates and the price of oil. Looking at the current scenario, it is anybody’s guess as to where crude oil price settles: could be above $80?

In 2017-18, India’s trade deficit has almost doubled, touching $87 bn, over the previous year. That aside, there is an abrupt acceleration in CPI inflation excluding food and fuel during April, 2018, RBI has revised its inflation forecast upwards for the first half of 2018-19 to 4.8 – 4.9% and 4.7% for the second half as against the earlier figure of 4.4%. Now, with the rising oil prices, revision in the MSPs for kharif crops and widening trade deficit, inflation may rise faster than expected. With the uncertainties associated with the current global interest rates scenario, there appears to be precious little that RBI could do to fix a fair value for rupee even with its large kitty of reserves.

Over it, the mounting fears about political instability in Italy and Spain have already sent tremors through the Eurozone’s bond markets. The resulting financial crisis might weaken euro, strengthening dollar, which incidentally makes the job of the RBI that much more complicated.

That aside, one estimate indicates that in general with every $ 10 increase in the price of a barrel of oil, growth rate falls by 0.2% to 0.3%. ndeed, it is the low oil prices that made Indian economy the world’s fastest growing economy in the recent years. Obviously, the government is worried about the rise in prices that are “way above a reasonable price.”

So, tough times are ahead for the policy makers!


More by :  Gollamudi Radha Krishna Murty

Top | Analysis

Views: 3248      Comments: 0

Name *

Email ID

Comment *
Verification Code*

Can't read? Reload

Please fill the above code for verification.