Ind-Ra: Oil Headwinds to Widen FY19 Current Account Deficit by USD22 billion-31 billion

India Ratings and Research (Ind-Ra) believes a combination of elevated crude oil price and weak rupee, if sustained for more than a quarter, will have an adverse impact on India's current account position, inflation, monetary policy stance and fiscal balance. If crude basket averages USD68-72.86/bbl and rupee averages 66.6-67/USD for FY19, the current account deficit could widen USD22 billion-31 billion in FY19. Wholesale inflation could also increase 70-80bp from the agency's current forecast of 3.4% and retail inflation 30-35bp from its current forecast of 4.3%.

Status Quo on Policy Rate in June 2018 Review: Ind-Ra believes the Reserve Bank of India's Monetary Policy Committee (MPC) will keep the policy rate unchanged in its upcoming review. Although the MPC minutes from April's policy review indicate a potential shift in the Reserve Bank of India's liquidity stance to 'withdrawal of accommodation' from current 'neutral' stance, the agency believes the MPC will wait for the outturn of monsoon and its distribution, and further movement in crude oil prices before deciding on the rate hike. In the interim, financial market conditions have already tightened. A mix of global and domestic factors such as risk aversion among global investors, crude oil price volatility, higher borrowing by the state governments and a likely fiscal slippage by the central government has driven the bond yields higher. The 91-day Treasury bill rates increased to 6.4% in May 2018 from 6.11% in April 2018, while the 10-year G-sec rate rose to 7.88% from 7.15% during the same period.

States Have More Headroom to Provide Relief on Domestic Oil Prices: The value added tax imposed by the states is on ad valorem basis. Therefore, with a rise in oil prices, the state governments garner higher revenue from the sale of same quantity of oil as opposed to the central government whose excise duty is fixed in terms of INR/litre. A surge in crude oil prices, therefore, gives the state governments more headroom to rationalise the tax rate without compromising much on their fiscal arithmetic.

Crude Oil Prices Expected to Correct: Ind-Ra believes the crude oil prices will correct from the present high of around USD78/bbl due to increased US shale production. Moreover, elevated crude oil prices are not in the best interest of oil producing countries as well, because it aggravates the risks of jeopardising the ongoing global recovery. Ind-Ra's base case macro-economic forecast is based on average Brent crude at USD70/bbl in FY19. This corresponds to Indian crude basket of approximately USD68/bbl.

Ind-Ra has published its third edition of Arth Samvaad which provides a monthly macroeconomic analysis of the key domestic and global developments along with the heat map of the Indian Economy using high frequency data. The theme article of this edition takes a deep-dive into the crude oil dynamics and its impact on various aspects of the Indian economy.

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