Fall in oil prices is good news, as every $10/bbl price swing impacts the current account deficit by $8 billion.
First, the good news: S&P’s rating cut for the United States bodes well for India, as it will help the Reserve Bank of India in its battle against inflation. For starters, Brent crude oil prices have corrected substantially (down by about 15 per cent from the recent highs), with other commodities expected to follow suit. With the US and the euro zone expected to record softer growth, oil analysts expect Brent to average at $108/bbl in FY12 and $114/bbl in FY13. If the US goes into a mild recession, Bank of America Merrill Lynch’s (BoAML) oil analyst Franchisco Blanch expects dated Brent prices to come off to $80/bbl. Not only will this help battle inflation, it will also keep fiscal deficit in check.
Many experts are likening this crisis to that of 2008, and this has brought back some of the noise on the risk to India’s external debt. During the Lehman collapse, “vulnerability” rankings became quite the fad, which simply added up the current account deficits and forex reserves to short-term debt ratios. BoAML believes the RBI should be able to withstand any possible contagion following S&P’s US downgrade. However, S&P has warned that even as there is no immediate impact on the Asia-Pacific sovereign ratings, the potential longer-term consequences of a weaker financing environment, slower growth and higher risk aversion are negative factors. Economists believe things could get tough only if oil crosses $135/bbl, which seems unlikely in a slowing growth environment.
G Chokkalingam, ED & CIO of Centrum Wealth Management, says the expected depreciation of the dollar could reduce India’s import bill (for oil and fertilizers), which, in turn, can strengthen India’s fiscal condition by reducing the subsidy bill significantly. Moreover, a sell-off will tighten the liquidity in the domestic system, easing the job of the regulator in contracting liquidity for taming inflation.
The next big question is if India can fund its high current account deficit if risk aversion dries up capital flows? Economists believe India can fund it as risk aversion will also lead to lower oil prices, which will have a positive impact on the current account. For every $10/bbl rise or fall in oil prices, the impact on the current account deficit is of $8 billion. Clearly, falling oil prices are a bigger boon than the threat of capital outflows. For now, it’s widely believed there won’t be any massive sell-off in equities, as was the case in 2008-09. The US, Europe and Japan have their own problems and are expected to post very low GDP growth or fall into recession in the near future, claim experts. Moreover, a sell-off will further pull down India’s valuation to 12x FY13 EPS, making it a rather attractive destination.
