Oil - Destabiliser for Macro; Resilience of Indian Economy to Limit Shock

While the Indian economy was recovering from the twin shocks of demonetisation and the Goods and Services Tax roll-out, a combination of an elevated crude oil price and a weak Indian rupee has given rise to jitters in the Indian economy, says India Ratings and Research (Ind-Ra). However, the agency believes that the Indian economy is in a much better shape than it was in 2013, when taper tantrums triggered by the US Fed's decision to wind down its bond-buying programme led to a sudden, sharp depreciation of the Indian rupee. A free fall of the Indian rupee also resulted in India's inclusion in the club of Fragile 5, along with Brazil, Turkey, South Africa and Indonesia.

However, India's current macroeconomic environment is far more robust than it was in 2013. While GDP growth and foreign currency assets are higher, current account deficit, retail inflation, interest rate and fiscal deficit are lower.

Ind-Ra expects (i) crude prices to average around USD75/bbl and (ii) the Indian rupee to average 67/USD in FY19. Nevertheless, these numbers are higher than the ones used by the agency for the FY19 macroeconomic forecast, published in April 2018. Therefore, Ind-Ra believes a revision is in order.

Indian Rupee to Depreciate; NRI Deposits May Help: Ind-Ra expects the average value of the currency to depreciate 4% to INR67/USD in FY19 (FY18: INR64.45/USD) owing to global factors such as lower capital inflows to emerging markets, a likely slippage on the fiscal consolidation roadmap and a higher current account deficit due to high crude oil prices. The pace of capital inflows and foreign currency assets has a strong impact on the value of the Indian rupee. During the last episode of the Indian rupee depreciation, India had mobilised NRI deposits to provide support to the currency. This was mainly responsible for the value of the Indian rupee appreciating to INR60.10/USD at end-March 2014 from INR68.34/USD as on 28 August 2013.

Crude Oil Prices to Correct, Albeit Current Account to Widen: Global crude oil prices corrected to around USD74/bbl on 22 June 2018 from USD80.50/bbl on 22 May 2018, according to ICE Brent. However, Ind-Ra believes it is unlikely that the crude oil price would average close to its earlier assumption of USD70/bbl in FY19. Ind-Ra's base case assumption of Brent crude oil price for FY19 is USD75/bbl, which, along with the Indian rupee averaging INR67/USD, will widen the current account deficit to 2.6% of GDP in FY19, the highest level in the last six years. OPEC and non-OPEC countries decided to increase crude production by 1 million bbl/d. It is unlikely that the proposed increase in the global oil supply would have any meaningful impact on prices until production-related issues in Venezuela, Libya, Mexico and Iran are resolved.

Inflation Likely to Breach RBI's 1HFY19 Target: Ind-Ra believes retail inflation in June 2018 would breach the Reserve Bank of India's (RBI) revised inflation projection of 4.8%-4.9% in 1HFY19. However, unfavourable base effect will start waning from July 2018. Factoring in the evolving crude oil price situation, Ind-Ra expects retail price inflation to come in at 4.6% in FY19 (FY18: 3.7%). The inflation forecast does not factor in the revised minimum support price, which is likely to be announced in August 2018, most likely after the RBI's third bimonthly monetary policy. A sequential decline in high frequency data index of industrial production, vehicle sales and air traffic, and hardening of interest rates in the economy will have an impact on the decision of the Monetary Policy Committee. Ind-Ra expects another rate hike during the remainder of FY19, but attaches a low probability to a rate hike in the August 2018 policy review.

GDP Growth: In light of deterioration in the current account, higher inflation and interest rate, it is highly unlikely for the GDP growth to remain unaffected. At present, Ind-Ra is maintaining its FY19 GDP growth forecast at 7.4% and will reassess it once it receives further information on the progress of the monsoon. Cumulative rainfall between 1 June 2018 and 24 June 2018 has been 11% below normal. Only the Southern Peninsula received 25% higher than normal rainfall. Nevertheless, Ind-Ra believes FY19 growth performance is likely to have two distinct halves. The strong base effect of 1HFY18 would translate into a higher growth in the range of 7.7%-8.0% in 1HFY19 and the high base of 2HFY18 is likely to keep GDP growth in the range of 6.7%-7.0% in the 2HFY19.

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