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Insights into Editorial: Breathing space: on the strengthening rupee


Insights into Editorial: Breathing space: on the strengthening rupee


 

Introduction:

Rupee strengthens little with softer oil, fund flows:

Softer crude oil prices, along with foreign fund inflows, helped the rupee post over 1% gain against the dollar, giving hope for the current account deficit to remain within the tolerance limit and for a further reduction in petrol and diesel prices.

This is no surprise since imported oil meets about 80% of India’s total demand. The value of the rupee tanked amid the uptrend in oil prices which lasted till early October.

Fuel prices across major Indian cities have fallen significantly in the last few weeks.

 

Indian Scenario:

India has 0.5% of the oil and gas resources of the world and 15% of the world’s population. This makes India heavily dependent on the import of the crude oil and natural gas.

India is the fourth-largest Liquefied Natural Gas (LNG) importer after Japan, South Korea and China, and accounts for 5.8 per cent of the total global trade.

India the third-largest oil consuming nation in the world and  India’s oil consumption grew 8.3 per cent year-on-year to 212.7 million tonnes in 2016, as against the global growth of 1.5 per cent.

 

Impact of fall in Crude oil prices on Economy:

The fall in global crude oil prices comes as a big relief to the Central government, which has faced increasing macroeconomic and political pressure due to rising prices.

According to UBS, a drop of $10 in the price of oil can improve India’s current account and fiscal deficits by 0.5% and 0.1% of GDP, respectively.

The Reserve Bank of India will be relieved as it will have to worry less about the rupee and oil-induced inflation.

This points to an increase in investor confidence in the economy as the fundamentals improve.

But rising global uncertainties, it may not be so easy to map what lies ahead for global crude oil prices and the rupee.

The December 6 meeting of the Organisation of the Petroleum Exporting Countries will make clear the response of oil producers to the sharp fall in prices.

Shale companies are also likely to respond to falling prices by cutting production; the profit break-even point for shale producers.

 

Rising oil prices could take a bite out of India’s economy:

Rebounding oil prices have pushed up oil import costs and will widen India’s currency account deficit. This will in turn weigh on the rupee, which is expected to depreciate further.

That widening deficit will result in a weakening rupee, as more imports mean India has to buy more foreign currencies to meet its needs.

India could overtake China as the world’s largest oil demand growth center by 2024, according to a Wood Mackenzie report.

 Crude Oil Demand is expected to grow by 3.5 million barrels per day from 2017 to 2035, accounting for a third of global oil demand growth. That’s driven by rising income levels, a growing middle class and increasing need for mobility.

 

Will rupee strengthen?

As the dollar is strengthening and all accompanying fundamentals are strong, it looks difficult.

There are three important elements linked to the weak rupee:

  • Persistent current account deficit;
  • Episodes of net capital outflow in terms of speculative and debt capital outflow; and
  • Predominance of debt capital in forex reserves.

In the event of rupee depreciation, the RBI intervenes in the forex market with the objective of containing volatility.

This decline could be on account of the RBI selling dollars to intervene in the market to manage rupee volatility.

However, our efforts to further strengthen FDI and promote exports by diversification, improving the quality of our commodities, and focussing more on developing and emerging market economies will be helpful.

That is the only long term sustainable and viable way to prevent the rupee from falling.

 

Conclusion:

Oil prices have shot up this year, and are set to go up further when sanctions on Iran kick in.

While currency dealers said the Reserve Bank of India was not present in the market, the strengthening of the rupee gave an opportunity to boost foreign exchange reserves.

The total foreign exchange reserves for the end of November 9 were $393 billion, down by $33 billion since its peak in April this year.

 

Way Ahead:

Government should focus on making strategic reserve storage facilities now as Gulf Countries are looking towards tapping the Indian oil demand due to low import demand form America owing to availability of shale gas at cheaper rate.

Moreover, Oil Corporation of Gulf Countries have shown interest in storage-refining in India since it can reduce their transport costs into Southeast Asia.

In future, Government may readily utilise this storage facility in the international markets as it can release inventory and book profits when prices climb, and recharge reservoirs when prices fall again.

India should look at using renewable energy to meet multiple objectives by increasing production: energy security, energy efficiency, decarbonization, and sustainability, among others.

India should capitalise on the relief offered by the fall in oil prices to improve its preparedness for any future jump in oil prices.