At this point, it looks like the impact of the anticipated drop in global growth and trade would outweigh any gains to exporters from the weaker rupee and opportunity in markets like steel from the sanctions on Russia.
The rising prices of oil and several other commodities, now exacerbated by the Russia-Ukraine conflict, are certain to have an adverse impact on the economy. India’s dependence on oil may have come down over the years, but it is still a high 3% of GDP.
The consumption of oil, as the economy gets back on track, is pegged at around 1.4-1.5 billion barrels annually. At a price of $120 per barrel, which is $40 above the average for the December 2021 quarter, the import bill would go up by an estimated $60 billion. In addition, the higher costs of other imports such as gas, fertilisers, coal and edible oil would push up the bill by another $35 billion.
The fatter import bill coupled with a marginal hit to exports arising from weaker demand in Russia and Europe, as also slowing global growth, would result in a wider current account deficit—if oil prices stay close to $100, the CAD could end up at around 2.8-3% of GDP in FY23. That is about 110-130 bps wider than the expected deficit in the current fiscal. Given the forex reserves of $640 billion, it shouldn’t cause any panic, but the rising trade deficit could weaken the rupee, now ruling at 76.16 to the dollar, on the back of a strengthening dollar. To be sure, that would help exporters, but only if the depreciation is bigger than for the currencies of rival economies. At this point, it looks like the impact of the anticipated drop in global growth and trade would outweigh any gains to exporters from the weaker rupee and opportunity in markets like steel from the sanctions on Russia.
The damage to the economy could be severe if oil prices rule at over $100 per barrel because the import bill would jump by about $100 billion. The huge inflationary impact is bound to hit consumption and, in turn, growth. Indeed, consumption would weaken even if the entire inflationary impact of the higher import bill is not passed on. It is important, therefore, that the government seriously consider keeping fuel costs as affordable as possible. To be sure, leaving the levies at the current level—pegged to an oil price of $80 per barrel—would be best because at Rs 27.9/litre and Rs 21.8/litre on petrol and diesel, respectively, the levies are already fairly steep.
If that is not possible, it would help if some of the additional increase of around Rs 10 per litre—for the rise in prices from $80 to $100—was to be absorbed the Centre because, as of now, it would appear there is room for this. The revenue targets for FY23, pegged at Rs 27.58 lakh crore, are somewhat conservative and economists estimate there could be a cushion of at least Rs 1 lakh crore.
If the government doesn’t absorb a big share of the increased fuel cost, retail inflation could spike by about 60 bps or even more depending on where oil prices go. In itself, this might not seem significant, but if retail inflation goes well past 6%, RBI would find it difficult not to tighten monetary policy. That, then, would push up interest rates across the board, hurting the businesses of companies, especially MSMEs, and stymieing demand for home loans.
There is no doubt that if the government absorbs the higher prices of oil instead of passing them on, it will need to curb expenditure. However, at this point, it is important that interest rates and inflation don’t spiral out of control because that would hurt the nascent recovery, especially in the informal sector. The Centre must make up for the lower tax collections with more revenues from disinvestments. That way, it need not scale back expenditure too much and would be able to support growth.
