Preparing for cheaper oil

RBI should guard against rupee volatility if forex inflows resume

The sudden and sharp fall in the global price of crude oil has thrown up a set of decisions for Indian policymakers. On the one hand, a reduction in the price of oil is always a benefit for India, which imports over 80 per cent of its crude oil. The price of the Indian basket of crude oil has averaged around $74 a barrel so far this financial year; but there is some hope that it will stay in the $55-60 range for some time, creating favourable cost conditions for the economy and hopefully stimulating the Reserve Bank of India (RBI) into cutting interest rates and giving investment and growth a boost. The full-year import bill may turn out to be considerably lower than the revised estimate of $125 billion provided by the petroleum ministry just last month.

However, this fall in the global oil price may also have a consequence that needs to be prepared for. It is possible that, once again, foreign portfolio investors (FPIs) will put money into the Indian economy — which is perhaps good news for the stock markets, but from the point of view of the larger economy is a mixed blessing at this point. In November so far, net inflows turned positive after almost $400 billion outflows in the previous month. The fear is that the effect will be renewed rupee volatility. The thinness of the foreign exchange markets in India means that a surge in FPI flows would have a disproportionate effect on the rupee-dollar exchange rate, and possibly hurt the incipient revival in Indian exports, which till recently had been flat for years even amid a revival of global growth. The RBI has to be on guard against the possibility. It is true that the central bank no longer has currency management as an objective. However, this is a good moment for it to build up its reserves. If the rupee is too over-valued for Indian exports to experience sustained growth, then it must eventually fall, in spite of a transitory spike in FPI inflows, and the RBI should logically use its ability to build dollar reserves to manage the rupee’s long-term fall.

The government should also consider what the impact of the fall is on its own fisc — it may not require a decrease in oil excise in order to satisfy populist pressures ahead of the Lok Sabha elections next year. Indeed, if it is having trouble meeting its fiscal deficit targets, it may be able to reverse its recent reductions in fuel taxes. However, any assumption that oil has found a permanent, lower level is not warranted. This price fall, which may last into the medium term, is thanks to a fortuitous combination of circumstances that include the Saudi Arabian government’s need to placate the United States following the murder of dissident journalist Jamal Khashoggi, and the US’ decision to provide exemptions to major consumers of Iranian oil, including India, from new sanctions against the Islamic Republic. Such geopolitical considerations cannot be counted on to continue forever. Freeing the Indian economy from its long-term dependence on global price needs fresh attention.