High crude oil price + weak rupee = Wider CAD

At its three-day monetary policy review beginning Tuesday, the Reserve Bank of India (RBI) would look at higher crude oil prices, a weak rupee, and the resultant inflation situation among the risk factors to monitor. While the first two could affect the current account deficit (CAD), inflation could determine the central bank’s monetary policy stance.

New Delhi–based Devendra Pant, chief economist and head-public finance at India Ratings and Research (Ind-Ra), believes a combination of elevated crude oil prices and a weak rupee, and if these sustain for more than a quarter, will have an adverse impact on India’s current account position, inflation, monetary policy stance and fiscal balance. “If crude basket averages $68–72.86 per barrel and rupee averages 66.6-67 per US$, the current account deficit could widen to $22-31 billion in FY19,” says Pant.

Wholesale inflation could also increase by 70-80 basis points (100 basis points make one percentage point) from Ind-Ra’s current forecast of 3.4% while retail inflation could move up by 30-35 basis points from the rating agency’s current forecast of 4.3%, Pant believes.

On the RBI’s rate action, Ind-Ra believes the central bank’s Monetary Policy Committee (MPC) would keep the policy rate unchanged. Although the minutes from April’s policy review indicate a potential shift in the RBI’s liquidity stance to ‘withdrawal of accommodation’ from the current ‘neutral’ stance, Ind-Ra believes the MPC will wait for the out-turn of monsoon and its distribution, and further movement in crude oil prices before deciding on a rate hike. “In the interim, financial market conditions have already tightened,” says Pant in a note. “A mix of global and domestic factors such as risk aversion among global investors, crude oil price volatility, higher borrowing by the state governments and a likely fiscal slippage by the central government has driven the bond yields higher.” The 91-day Treasury bill rates increased to 6.40% in May 2018 from 6.11% in April 2018, while the 10-year G-sec rate rose to 7.88% from 7.15% in the same period, he says.

However, there could be some relief. The rating agency believes crude oil prices would correct from the present high of around $78 a barrel due to increased US shale production. “Moreover, elevated crude oil prices are not in the best interest of oil-producing countries as well, because it aggravates the risks of jeopardizing the ongoing global recovery,” Pant notes.

Clearly, there are more worries for the RBI as they attempt another tightrope walk while the global economy and markets are witnessing bouts of volatility.