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Monday, January 26, 2015

Oil at 50, INR at 62 : A Paradox or not?

In September 2014, when oil was $100 and INR 61, if a poll was conducted about the level of INR should oil fall to $50, an overwhelming majority would have suggested INR at 50-55 in our opinion.

12th January 2015: Oil is $50 but INR is 62. Is this a paradox or has something changed?

On discussing this with economists & experts, one reason cited was the strength of US$.

The fallacy in the US$ strength argument

A $50 fall in oil prices equals a saving of 2.5% of GDP in CAD as against CAD of 1.9%, 1.1% and 1.3% (as % of GDP) in the previous three quarters of FY15 respectively. These savings are so real and so massive, that they have the potential to alter the USD/INR demand supply equation on a sustainable basis. In view of this, the indirect impact of strength of USD, if any, should be moderate and temporary in our opinion.

It is therefore surprising that the INR has actually depreciated by 4% v/s US$ in this period.

A possible explanation

The fall in oil price is not only a recent one but a sharp one too. Consequently, the quarterly average prices are falling with a lag. Further, India’s oil imports enjoy nearly a six week credit period, which implies that the effective price for India on cash basis will fall sharply in Jan-Mar15 and Apr-Jun15 quarters.
  • Does this imply that Jan-Mar15 & Apr-Jun15 quarters will experience a current account surplus?
  • If the above analysis is correct, then are we in for interesting times for the INR?
The Way Forward

Yield on ten year benchmark government bond has come down from ~8.8% in Jan 2014 to ~7.7% as on January 15, 2015. As this fall is lower than fall in inflation, real rates of around 3.25% are quite high compared to past levels. In view of high real rates, benign outlook on inflation, falling fiscal deficit and a sharp improvement in current account deficit, there is reasonable room for yields to move even lower in the medium term. We continue to expect growth to gradually improve over the next year leading to a possibility of a sovereign rating upgrade. In view of the above, we reiterate our view of lower rates over the medium term.

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