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US policy tightening stance, rising crude may see rupee test previous all-time lows

Rise in average price of crude oil to $75/bbl in FY2019 would boost net oil imports

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A lot of data on the health of India's external sector was released in the week gone by, much of which revealed cautionary trends.

As expected, India's current account deficit deteriorated to $13 billion in Q4 FY2018 from $2.6 billion in Q4 FY2017, and nearly equalled the full-year deficit of $14.4 billion recorded in FY2017. The relief related to a contraction in gold imports was dwarfed by the larger imports of items such as crude oil, coal, chemicals and metals, following a rise in commodity prices. This serves as a timely reminder of the adverse impact that soaring prices of commodities, have on the external balances and the currency movement of net importers such as India.

In keeping with this trend, the trade data for May 2018 indicated that the merchandise trade deficit widened to $14.6 billion in that month from $13.8 billion in May 2017, even though merchandise exports expanded by a heartening 20.2%, outpacing the 14.8% growth in merchandise imports.

The growth of non-oil non-gold merchandise imports rebounded to double-digits in May 2018, driven by a variety of industrial inputs, agricultural inputs, as well as consumer items. Moreover, the net oil import bill surged by over 20%, on the back of higher prices. However, the imports of pearls, precious and semi-precious stones recorded a considerable contraction, in line with the YoY decline in gold imports, as well as the de-growth in exports of labour intensive gems and jewellery in May 2018.

Export growth in May 2018 was driven by agricultural produce, chemicals, and engineering goods. The labour-intensive textiles sector recorded a mixed trend with expansion in yarn/fabric/made-ups offset by weakness in readymade garments.

Looking ahead, a rise in the average price of the Indian crude oil basket to $75/barrel in FY2019 would boost net oil imports by $30 billion to $100 billion in the ongoing year. However, higher crude oil prices and a weaker rupee would improve remittances and the competitiveness of exports. On balance, we expect India's current account deficit to widen by around $20 billion to $65-70 billion in FY2019 from $48.7 billion in FY2018.

The Indian currency has started FY2019 on a bearish note, depreciating by a considerable 4.5% relative to the US dollar till mid-June 2018, amid relatively secular dollar strength. Moreover, the rupee has been among the worst performing Asian currencies in the current fiscal.

Further monetary tightening by the US Federal Reserve in the second half of 2018 and the shrinking of its balance sheet would impart continued strength to the dollar in the coming months. Moreover, rising global yields and asset market returns may dampen the FIIs appetite for Indian debt and equity, in the run-up to the parliamentary elections in 2019, which will weigh upon the sentiment for the rupee.

Additionally, if crude oil prices start retracing towards $80/barrel, the negative sentiment related to a rising current account deficit and inflationary risks may spur the rupee to intermittently test the previous all-time lows.

CAUTION AHEAD

  • Growth of non-oil non-gold merchandise imports rebounded to double-digits in May
     
  • Higher crude oil prices and a weaker rupee would improve remittances and the competitiveness of exports

The writer is a principal economist with ICRA

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