Oil price, Moody's improved outlook, low interest rates: Tough call for RBI

While the share of oil in India's import basket is as much as 22.5% currently, a falling rupee could fuel inflation and take the steam out of low interest rates

Petroleum and natural gas minister Hardeep Singh Puri cannot be faulted if he has set the number of Prince Abdul Aziz bin Salman Al Saud, Minister of Energy of Saudi Arabia on his speed dial. Since July, when Puri took over the portfolio, he has spoken twice with the Kingdom. 

With the benchmark Brent crude price at over $82 a barrel, coming uncomfortably close to the century mark, Puri may need to pick up his phone for the third time. If he has some good news to share, it will be listened to eagerly by the Reserve Bank of India pundits, who will announce their decision on interest rates on Friday. They have got one piece of good news already, with Moody’s this week improving India’s outlook to stable from negative. 

Oil, as a percentage of all imports by India, had peaked at 25 per cent in FY20. It is already 22.5 per cent in this financial year and those have uncomfortable implications for the economy, especially rupee.

The pressure on the rupee to depreciate will be more since the Reserve Bank of India is running an “accommodative” monetary policy. More rupee in the markets mean there is pressure on prices to rise, which is inflation. The rising prices of oil and gas mean they are adding an external dose of inflation to the domestic mixture, from abroad. 

A sustained high inflation will keep the rupee depreciating. The important question for business is whether the downward move will be gradual. A Wells Fargo note says it will be so: “We forecast any softness in the currency to be relatively gradual in nature”. The bank reasons the pressure on the rupee to depreciate will sustain since the RBI will keep monetary policy accommodative “in an effort to prioritise growth. Accommodative monetary policy through 2022 should keep depreciation pressure on the rupee for the time being”.

The confidence among business people, and especially investors that they can afford to borrow money at cheap rates is certainly something the economy needs. It is one reason why investors are backing startups with more and more distant ideas. 

But as the rupee depreciates despite the low interest rates, the cost of borrowing will rise. Because a large chunk of the borrowing is in foreign currency, which makes a depreciating rupee expensive. The RBI pundits in the monetary policy committee who will speak on Friday will thus have to figure out if pushing the growth pedal will send the rupee even more downwards. RBI is rapidly getting isolated as the only emerging market central bank to have kept interest rates down. It will be hoping its bets stay good even though rising prices of oil and natural gas is bad news for India at any time. This year there is a global gas shortage which has pulled up the price of oil. Crude oil imports have increased by 3.1 per cent in August. In this financial year (April-August) it has risen by 13.2 per cent over the same period last year. For the Indian economy not to judder, the growth rate cannot be tapered. So it is essential for India that the prices should ease off. The price of the Indian basket averaged $69.80 per barrel in August 2021 but has since climbed to $76.89 in September. While no one expects the price to revert to $44.19 per barrel seen in August 2020, the current prices are too high. 

The government managers are, of course, keen that rates stay low. The money illusion is keeping the economic revival ticking, they feel. One evidence is the sharply rising taxes being paid as Goods and Services Tax. Over the past 12 months, GST receipts have averaged over Rs one trillion for eleven of those. 

With the higher tax inflow, GOI feels it has helped the markets, telling them it shall not borrow more. So the investors are supposed to be confident they can raise money without having to compete with the government to offer competitive returns. The message has certainly gone home with the yields on benchmark government bonds having softened. This plus the high forex reserves India has assiduously built up is of course most handy at this stage. The reserves are $ 638.6 billion as on October 1, 2021.

The trigger is therefore clearly how the rupee depreciates. It will, as most commentaries agree. The question is how much? The government has also helped itself this year having brought all its subsidies and guarantees up front. So there is no hidden danger in the government books to worry about. For a sliding currency those could have gone badly. 

The risks for the currency now centre around the possibility of any large domestic company getting into trouble. If the RBI has to withdraw from its accommodative stance to raise interest rates, those risks do certainly rise. But as the latest Financial Stability Report of the Bank notes, the contagion risks from new entities do not seem high at the moment.