Falling Re, rising crude reignite inflation fears

Shishir Sinha New Delhi | Updated on May 08, 2018 Published on May 07, 2018

Fiscal deficit to face pressure; interest rates may harden

The Narendra Modi government approaches its fourth anniversary on a distinctly inauspicious note, with crude oil prices touching a four-year high and the rupee sinking to below 67 to a dollar. This is likely to lead to higher inflation and a further hardening of interest rates.

The deepening economic crisis in Venezuela and suspense over the US decision regarding sanctions on Iran fuelled a rally in Brent crude oil futures on Monday. It opened at $75 a barrel and hit $75.95, its highest since November 2014. This movement will affect the price at which Indian refiners buy their crude.

The Indian basket of crude oil represents a derived package, comprising Sour grade (Oman & Dubai average) and Sweet grade (Brent Dated) crude oil processed in Indian refineries in the ratio of 72.38:27.62.

Coupled with the rise in crude prices, the rupee dipped to a new 15-month low. It closed at 67.13/14 against the US dollar. The markets expect the rupee to sink further, which in turn will ramp up oil prices. The price of Indian crude basket was $71.60/barrel on May 4 with an exchange rate of ₹66.77.

Devendra Pant, Chief Economist, India Ratings, said that a long period of elevated oil prices and a depreciating rupee would be unfavourable for the Indian economy. “If the rise in oil prices is passed on to the consumers, it will have an inflationary impact. It will certainly impact the household’s inflationary expectations, a crucial input for RBI’s monetary policy,” he said. The issue was also pointed out at the last meeting of the Monetary Policy Committee on April 4-5.

Supply cuts & global demand

According to the minutes of the meeting, Viral Acharya, RBI Deputy Governor, said that a combination of OPEC supply cuts and strengthening global demand seemed to be exerting an upward pressure on international oil prices. Volatility in these elevated prices had, however, been relatively low in the past three to six months. “On the domestic front, the lack of fiscal space to go easy on fuel cesses implies that prices at the pump will likely mirror movements in international prices. Since global commodity prices as a group are refusing to budge, the overall outlook is not comforting from the standpoint of domestic inflation,” he said.

“Checking the fiscal deficit is equally important. If fiscal deficit in FY19 deviates from its budgeted target, it may lead to monetary tightening,” Pant said.

Shubhada Rao, Chief Economist with YES Bank, felt that hardening of international crude oil price was likely to manifest itself via higher pressure on India’s twin deficits along with inflation, while also having a marginally negative spillover on growth.

However, according to Rao, higher oil prices would translate into higher remittance inflows into India from oil exporting countries. State VAT collections linked to oil, which are ad valorem in nature, would improve.

Aditi Nayar, Principal Economist, ICRA, said the muted trend in food prices and weak transmission of crude oil prices may offset the need for an immediate rate hike. “While a few MPC members may vote for a change in stance in the June 2018 policy, we see limited likelihood of change until there is greater clarity on various inflation and fiscal risks, which may emerge by August,” she said.

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Published on May 07, 2018
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