Soaring crude oil prices weigh on the rupiah. When will the pain stop?

Mumbai: The vise of rising crude oil prices appears to be tightening around the Indian rupee.

On Friday July 1, the INR touched a low of 79.20 against the US Dollar before falling back to 78.94. Things have been pretty miserable for the Indian rupee since the outbreak of the Russian-Ukrainian war which led to a menacing spike in crude oil prices and consequently triggered a contraction in the country’s external balance sheet.

The situation is serious enough that economists and FX experts are now easily viewing the USD-INR at the 80-81 levels as a fait accompli.

There was little relief in the last quarter, when India’s current account deficit (CAD) narrowed, albeit slightly.

India’s CAD, which is a measure of the difference between the value of imported goods and the value of exported goods, fell from a 36-quarter high of $22.2. billion in Q3FY22 to $13.4 billion in Q4FY22. While the CAD shrink is welcome, it is still quite high compared to the pre-Russian invasion of $8.1 billion seen in Q4FY21.

But sticking to quarterly CAD figures is missing the woods for the trees. On an annual basis, India’s CAD hit a three-year high in FY22 at $37.8 billion (1.2% of GDP), a far cry from the current account surplus $24 billion observed in FY21. A big contribution to the latest DAC figure comes from the merchandise trade deficit which widened to $189 billion in FY22 from $102 billion dollars in fiscal year 21.

A worker carries a bag full of sugar to load it onto a supply truck at a wholesale market in Kolkata, India, November 14, 2018. Photo: Reuters/Rupak De Chowdhuri

While exports grew an impressive 44% year on year, imports more than kept pace and outpaced the former, increasing 55.3%. Another area where the damage is clearly evident is the total increase in foreign exchange reserves (on a balance of payments basis), which increased by $47.5 billion in FY22, or half of its $87.3 billion additions for FY21.

Meanwhile, the Federal Reserve and its rate hikes triggered an outflow of funds from emerging markets, particularly India, further weakening the rupee.

Currently, the global forex landscape is undergoing tectonic shifts and the currencies of developing countries are suffering the consequences. Accommodative central banks like the Swiss National Bank and the Bank of Japan, known for their ultra-accommodative monetary policies, are also on the back foot and forced to reconsider their accommodative policies as inflationary pressures prove much more permanent than expected.

The specter of a recession and the tendency of investors to rush to the dollar as a counter-cyclical bet during downturns do not help the cause of global trade. With a global flight to the dollar, the dollar index – which measures the strength of the dollar against six other currencies – broke through the 20-year barrier of 105.5 on June 14.

Meanwhile, the RBI has been busy deploying the war chest of its foreign exchange reserves to stem the fall of the rupee. This is reflected in India’s foreign exchange reserves which have increased from $633.6 billion as of December 31, 2021 to $593.3 billion as of June 24, 2022.

“The RBI’s large dollar sales in March 2022 ($20.1 billion) were partially offset by the increase in the outstanding amount of the RBI futures position (+$16.7 billion) as of course of the month. Despite the recent decline, large foreign exchange reserves and the RBI’s exceptional futures position at US$63.8 billion in April 2022 should prevent a disorderly depreciation of the INR despite global headwinds. says an ICRA research note, while warning that “an increase in crude oil prices from current levels poses a risk to the INR. Amid global headwinds, we expect INR to trade between 77.0 and 80.0/US$ in the remainder of the first half of FY2023.”

When it comes to oil imports, there doesn’t seem to be much light at the end of the tunnel for the Indian economy. Inflationary woes for the common man are likely to stretch out for a long time given that the possibility of crude oil prices falling dramatically or even moderating a bit seems slim.

Representative image. Photo: Reuters/Angus Mordant

ICRA expects the price of the Indian crude oil basket to be between $100 and $120 for the remaining period of FY23. The rating agency estimates net oil imports to reach $145 to $150 billion, compared to $95.6 billion recorded in FY22.

Another research note from Emkay Global Financial Services raised the ghost of INR collapse which was last seen in the 2013 crisis.

“Constant INR intervention pushed the REER (Real Effective Exchange Rate) back into the overvalued zone. But declining FX reserves, consistently high commodity prices, limited exchange rate pass-through Inflation and high INR valuations will likely tip the balance towards a less interventionist exchange rate policy in the coming months.

The research note goes on to point out that since “speculative capital inflows tend to finance our consumption-oriented imports (energy, gold, electronics, machinery, chemicals, plastics, etc.), a strong overvaluation of the currency is not desirable for domestic production and job creation”.

He also says :

“Assuming the new global energy order entails prolonged difficulties in the oil market, India will have to react even more strongly in the meantime, with increased exports and reduced imports. Otherwise, the repetition of the RBI exchange rate cushions falling to 15% of GDP (a recipe for external instability, as seen in the 2013 ‘taper tantrum’) cannot be ruled out in the coming years.Thus, allowing the INR to weaken slowly over time is the right strategy, giving the CAD room to improve.Thus, we believe that the RBI could eventually let the exchange rate adjust to new realities, albeit in an orderly fashion, by letting it allowing it to act as a natural macro-stabilizer of the political reaction functions”.

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