Fiscal constraints and inflationary pressures are back to haunt India as crude oil continues to rally and the rupee weakens against the dollar.
The country is likely to grapple with internal issues and possibly weaker growth if oil prices stay at current elevated levels, Kotak Securities said in a note. A weak macro environment is only adding to its troubles, it said.
Higher inflation is in the offing in the light of surging fuel prices, following the pre-Karnataka poll tariff freeze of 19 days, according to the brokerage. In the year so far, Brent crude has rallied 19.3 percent, while the rupee has depreciated 6.8 percent against the greenback.
Here are the reasons why Kotak is cautious on India:
High Twin Deficits
India’s high consolidated fiscal deficit as a percentage of GDP and widening current account deficit at high oil prices makes it vulnerable to negative sentiment, said Kotak. However, the country has a low debt-to-GDP ratio and reasonable foreign currency reserves, making it less susceptible to damage, relative to other emerging markets.
The fiscal deficit ran above the government’s budgetary estimates of 3.5 percent for the financial year 2018. For the first 11 months of the year, the deficit stood at 120 percent of the revised estimate, running at 4.2 percent of the gross domestic product.
Retail and wholesale prices in India are on the upswing as global crude prices continue to firm up. The rising prices of fruits and vegetables and increasing housing rates add to inflationary woes.
Going ahead, Kotak estimates diesel and petrol prices to increase by Rs 4-6 per litre, as the government attempts to align domestic retail prices fully to global crude levels. It also forecast a near 50 basis points increase in consumer inflation for every $10 per barrel increase in crude oil price.
The rupee has depreciated in real effective exchange rate terms, after a period of false strength, the brokerage noted. Given a weak macro-environment, political uncertainty and high equity valuations, the rupee remains vulnerable to further correction.
Possible Rate Hikes
The Reserve Bank of India’s six-member monetary policy committee has held benchmark interest rates at 6 percent since June 2017, with a neutral stance. With inflation rising higher than expected and external vulnerabilities writ large due to a weakening currency, the central bank may need to consider a change in stance and an eventual increase in interest rates.
A sharp rise in revenue expenditure over the years and high interest payment on public debt have prevented any meaningful improvement in fiscal deficit, even in times of low oil prices, said Kotak.
Additionally, the country’s trade exports have failed to dramatically increase over the years, hinting at internal challenges, rather than external challenges of trade protectionism. Non-oil exports have hardly risen since financial year 2012, the Kotak report noted. In fiscal 2018, India also lost its competitive edge in exporting textiles and agriculture items.