Ukraine war, oil prices may force RBI to re-think rate hike cycle: Analysts

The Budget and RBI's last policy took a conservative estimate of crude prices $75 per barrel. This is likely to be a challenge going forward, economists say

The Russia-Ukraine conflict, which has extended the commodity bull-run, and likely interest rate hike by the US Federal Reserve in March may prompt the Reserve Bank of India (RBI) to re-think its policy normalisation schedule, say economists. Of the two, soaring Brent crude prices pose a greater threat to the RBI’s dovish stance, they say.

"The Union Budget and RBI’s monetary policy announcement came much before this crisis and did not factor in the impact of the crude price shock. Both, the Budget and RBI, hence took a conservative estimate of crude prices $75 per barrel. This is likely to be a challenge going forward," says a BoB Capital report.

Brent Crude Futures touched an intra-day high of $120/bbl on Thursday, its highest level in nearly nine years. So far in CY2022, Brent crude has jumped 52 per cent and is up about 32 per cent since the Budget presentation.

The impact of higher oil prices, economists say, will not only hit India's trade deficit and currency but will also impact inflation and fiscal situation.



According to Edelweiss Securities, if crude stays at $100/bbl, India's current account deficit (CAD) could widen by 1 per cent of the gross domestic product (GDP) and domestically, fuel pump prices could rise by Rs 10-15/litre (10 per cent), lifting headline retail inflation (CPI) by 60-70 basis points.

However, if oil price rises are absorbed by the exchequer via duty cuts, it could impound the fiscal space to the tune of 1 per cent of GDP (Rs 2.5 trillion).

The RBI pegged FY23 inflation at 4.5 per cent during its February policy meeting, which economists say, looks too optimistic.

"The pump prices of petrol/diesel/LPG have been frozen since November 2021 due to state elections, and need to be revised up by nearly 10 per cent for petrol/diesel and over 30 per cent for LPG to bring them on par with international prices," said a note by Nomura.

It added that rising farming costs (fertiliser/pesticide, diesel and farm equipment) are a source of additional upward pressure on inflation. Moreover, amid rising commodity prices and a narrowing output gap, consumer goods companies are set to further pass on higher input costs to consumers, which is likely to affect the retail prices of home appliances, vehicles, personal care products and non-durables.

Against this backdrop, Nomura suggests policy repo rates will need to rise from 4 per cent currently to 5.75-6 per cent by March 2023 to catch-up with the ‘should be’ curve on policy rates. It assumes inflation to be around 5.8 per cent in FY23.

Prasenjit K Basu, chief economist at ICICI Securities, meanwhile, expects 50 basis points of increases in the repo rate in Apr-Jul'22 as the headline inflation is already slightly above its target range.

The other policy challenge that the RBI faces is rate hike by the US Fed. More often than not, Fed’s tightening and oil spike triggers a downturn in the global economy. And this time, economic recovery is badly split between prices and volume; goods and services; US and EM; and large businesses and small. Global debt, too, is at an all-time high.

"But with the ongoing war, there is likelihood of Fed going slow on tightening, which will be a relief. Yet, downside risks to the global economy remain quite high. For India, growth could be hampered through exports slow down (lynchpin of recovery so far), trade deficit could widen due to oil spike while capital flows could be volatile due to geopolitical uncertainty and Fed tightening. This increases stress on BoP and makes RBI’s policy choices unenviable,” say analysts at Edelweiss Securities.

That said, with the geopolitical situation remaining fluid, economists say the RBI may stay in the wait-and-watch mode.

"Assuming that the situation remains fairly grim till the RBI’s April policy meeting, the central bank may have to change its 'accommodative' stance to 'neutral', even if it maintains status quo on the rates," says Madan Sabnavis, chief economist at Bank of Baroda.

Basu of ICICI Securities, meanwhile, expects oil prices to see a sharp pull-back by July 2022 if oil supply improves.

"$60/bbl is the threshold level above which shale oil extraction becomes viable in the older oil fields of the US north-east – while in Texas's Permian Basin, shale oil is viable even at $40/bbl. With Brent crude staying above that threshold for over a year already, a substantial increase in shale-oil investment and production is likely over the next half-year – with even greater investment and extraction of shale oil occurring if Brent stays above $100/bbl for a few months," he says.

With fuel prices moderating sharply in the latter period, and the earlier rate hikes reining in domestic demand, CPI inflation will stabilise in the 4-5 per cent YoY range in Aug- Dec'22, obviating the need for further increases in the repo rate, Basu adds.