Rupee plunge may blunt India’s inflation fight

If the government and the Reserve Bank of India (RBI) were hoping that a high base effect, which kicks in from December, would block the inflation spiral, they may find their estimates going awry, yet again.

The rupee’s relentless slide vis-a-vis the US dollar is likely to fuel inflationary pressures in the economy and weaken the central bank’s defences against high prices as it offsets some of the moderating impact of last 21 months’ rate hikes on domestic demand.

“It (rupee fall) will be definitely blunt the high base impact. We will have to rework the (inflation) numbers, as we had not taken this into account. We had expected December inflation at 8.2%, but now it could be 8.5% because of the rupee fall,” said Abheek Barua, chief economist at HDFC Bank.

Going by a Yes Bank report, every 10% fall in the rupee is likely to lift the inflation rate based on the wholesale price index (WPI) by 40 basis points. Since November 1, the rupee has declined 5.5% against the greenback.

Traders have been buying the ‘safe haven’ dollar amid the prolonged debt crisis in the euro zone. Back home, demand for the greenback from oil companies, major importers of crude oil, is further pulling the rupee down.

On the other hand, the headline inflation rate has remained above the 9% mark since December last year. Latest data show WPI inflation was 9.73% in October, compared with 9.72% in the previous month.

Both government and independent think tanks are of the view that the inflation print for December could be sharply lower from the current level, as the index had risen 1.53% month-on-month a year ago.

The December index had risen to 146.0 from 143.8 in November last year. Thanks to this high base, inflation was widely seen slipping December onwards towards the RBI’s target of 7% by the end of the fiscal in March.

“There could be a 1.00-1.25% fall in inflation in December from the current level on the basis of the base effect,” an economist at a private bank had estimated.
December WPI inflation data will be released on January 16.

However, the rupee’s recent fall—especially if the downtrend sustains—holds the potential to upset these calculations.
In its Macroeconomic and Monetary Development report in October, the RBI had also acknowledged that the depreciation of the rupee raises the risk of imported inflation.

“The rupee has depreciated by about 11% against the dollar during 2011-12 so far. India’s imports account for about 22% of GDP and depreciation of the rupee raises the risk of imported inflation,” the RBI had said in the October report.

Rupee depreciation has already started to push up prices in some sectors like automobile, consumer goods, and mobile phones. For instance, makers of consumer durables have raised product prices by up to 10%, as their import costs have gone up because of the rupee’s depreciation.

State-owned oil marketing companies, which sell diesel and cooking fuels at government-controlled prices, are also piling up revenue losses as a falling rupee is pushing up the cost of oil imports.    

Every rupee’s fall against the dollar pushes up the combined gross revenue loss for Indian Oil Corp Ltd, Bharat Petroleum Corp Ltd and Hindustan Petroleum Corp Ltd by a staggering `8,000 crore.

The current year’s gross revenue loss of these oil companies is already pegged at a massive `130,000 crore, and the government will now increasingly come under pressure to bear at least a part of the jump in production costs.

The dwindling rupee may have further complicated the labyrinth of issues facing the economy, but economists say easing commodity prices may be the silver lining here.

“The counter-impact of rupee depreciation on inflation could be the easing of global commodity prices,” Yes Bank said.
Prices of long steel futures on the National Commodity and Derivatives Exchange have slipped about 3% so far this month. Iron and steel have a 6.36% weight in the WPI basket.

From $103.37 per barrel on November 17, crude oil prices have eased to $97.26 today. Petroleum, crude and oil products have a 10.26% weight in the WPI basket.

If a barrel of oil is currently at $100 with rupee at 48 to a dollar, its domestic price will be 4,800 rupees. If the rupee falls to 50, the cost will rise to s5,000. However, if, at the same time, the price of crude eases to $97, the price will settle lower at Rs4,850 and negate the impact of rupee fall to an extent.

“I don’t think the rupee fall has overwhelming concerns yet, as we are seeing falling commodity prices,” said Robert Prior Wandesforde, chief India economist at Credit Suisse.

Market participants don’t expect the rupee to recover sharply in the near future, as global concerns in Eurozone continue amid lack of strong intervention by the RBI.

Last week, RBI deputy governor Subir Gokarn said market forces must determine the level of the rupee, indicating that the central bank was not keen to intervene in the currency market.

“Gokarn’s comments at a juncture when the rupee was around 51 per dollar level shows that the RBI is not extremely uncomfortable with the rupee at these levels, and they may not intervene,” said an economist at a private bank. NW18