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Russia-Ukraine Crisis: India Has $80 Billion War Chest To Fight Currency Volatility: Indranil Sengupta, CLSA

India is far better positioned than it was during previous oil price shocks: Indranil Sengupta, CLSA.

<div class="paragraphs"><p>A vendor counts U.S. dollars. (Photographer: Carolina Cabral/Bloomberg)</p></div>
A vendor counts U.S. dollars. (Photographer: Carolina Cabral/Bloomberg)

The high level of foreign exchange reserves built up by the Reserve Bank of India over the past few years will give India greater economic freedom amid rising geopolitical tensions. It will mean that India is far better positioned than it was during previous oil price shocks, said Indranil Sengupta, economist and head of research at CLSA.

"India has sufficient forex reserves to insulate itself from any major economic impact," Sengupta said in a conversation with BloombergQuint.

A simulation run by CLSA suggested that if oil prices go to $150 per barrel for two months and there is a $20 billion outflow of foreign portfolio holdings, the RBI could need to sell above $30 billion from its reserves to protect the currency from sharp depreciation.

At present, the central bank holds reserves of about $680 billion. About $600 billion is what I would see as adequate. So you have about $80 billion to spend and you will be called upon to spend about $30 billion. That would still leave you with a war chest of $50 billion. From that perspective, India is in a very different place compared to previous oil shocks.

Impact On Rupee

Still, macroeconomic variables will worsen and the rupee could come under pressure.

Sengupta sees the current account deficit at between 2% and 2.5% of GDP if crude oil price averages $90 per barrel in FY23. He sees the rupee weaken and trade in a band of 73-76.50 against the U.S. dollar.

As the RBI showed in December, that when the rupee crosses 76 it comes in and sells, said Sengupta, adding that with high reserves just the intent to sell is enough.

"When you have a big stick, you don't have to sell too much. Just to demonstrate your intention to sell is good enough. When you don't have enough forex reserves, the more you sell, the weaker you look, which is what happened to us in 2013 and 2018," he said.

Sengupta expects the global risk-off sentiment will impact Indian equity markets initially, as was visible on Thursday, but added that, in dollar terms, India may still outperform other emerging markets. "We have a currency that will outperform. So I would think India would do relatively better than other EMs from a dollar returns perspective." There will be an initial downside risk though, as equity valuations, world-wide and in India, are rich. "Typically, when valuations are high, any trigger is a trigger to book profits."

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Bond Market Impact

While the Russia-Ukraine crisis may not impact bond markets as much it does equities and currencies, bond yields are still seen rising to 7.5% this year. "Yields will head higher due to fiscal deficit and [if] the RBI hikes rates."

CLSA sees the RBI hike rates by 100 basis points over the next fiscal year. This is not so much because of inflation but as a way to correct the negative real rates.

"You cannot remain at 3.35%. It is okay to run negative real rates for a while, but when you run negative real rates for a long time you end up with long inflation problem," he said. "As the mid-90s showed, it requires the sacrifice of 2-3 years of growth to bring it down."

The RBI would also need to stay in step with global central banks. "If the U.S. Federal Reserve keeps hiking, RBI has to react. If you don't react now, you will have to raise rates more quickly later. If you start hiking now, you will avoid a jerk later."

Impact On Inflation & Growth

Risk of an inflation spike is relatively limited as price pressures are expected to ease by mid-year. Sengupta sees domestic inflation ease due to a good monsoon, weak growth and fairly tight money supply growth in the economy.

Any risk of an oil price hike driven inflation spike can be balanced out by lowering excise duties, he said.

If the government wants to keep pump prices at current levels, they need to spend about Rs 80,000 crore by way of excise duty cut. This should not be such a worry because if the RBI sells $30 billion, they will have more capacity to do open market operations (to support bond markets). I would think the government would not pass on the higher oil prices given that consumer spending is already weak.

Watch the full interview here: