MNI ANALYSIS: Oil Price Puts India Govt, Rupee In Tough Spot

--Crisis Unlikely But INR Recovery Needs Prudent Policies

By Stuart Allsopp

     SINGAPORE (MNI) - The U.S. dollar is trading within one percent of its

all-time high against the rupee at 68.80, as rising oil prices are removing a

major pillar of support for the Indian currency. A break above resistance at

68.80 would be a huge technical blow to the rupee and likely point to a

deterioration in the country's fiscal accounts should the government shoulder

the burden of rising oil prices.

--OIL WINDFALL IN REAR-VIEW MIRROR

     The 2015-2017 period of depressed oil prices was a major boon to the Indian

economy. MNI estimate that over the past three years the economy has benefitted

by over US$150bn, or roughly 6% of GDP, from the cheaper crude prices. With

Brent crude oil back at USD80/bbl though, and pump prices hitting new all-time

highs in local currency terms, the windfall is now in the rear-view mirror.

--FISCAL POSITION WAS MAIN BENEFICIARY

     The oil price windfall helped to boost India's fiscal position as the

government raised fuel taxes while keeping pump prices largely unchanged. These

consumption smoothing efforts allowed the fiscal deficit to narrow and prevented

a major surge in oil import volumes or non-oil imports. As a result, the

country's trade accounts improved markedly, with the currency account deficit

moving from -5.0% in 2013 to -1.5% currently. In total return terms the Indian

rupee was the best performing major EM currency over this period.

--FISCAL BOON TO FISCAL DRAG

     Now the government, with elections approaching, faces the tough decision of

whether to allow higher oil prices to squeeze consumers or to cut taxes to

prevent a surge in crude prices from impacting end users. Should the government

opt for the latter option at a time when the subsidy burden on kerosene and

cooking gas is also rising, the fiscal balance would take a severe hit, and with

it so would the currency account and the Indian rupee.

--NO LOOMING CRISIS

     The good news is that partly due to the central bank boosting its foreign

reserve holdings over the past few years, India's net international investment

position has improved and now sits at around 15% of GDP. The relatively low

level of foreign ownership of Indian government bonds, in particular, should

prevent a negative spiral of deteriorating fiscal accounts leading to portfolio

outflows, putting upside pressure on bond yields and leading to further

outflows. The rupee does not face a crisis, but higher oil prices will make a

recovery difficult in the absence of highly prudent fiscal policy.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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