MUMBAI: While the September 17 historic rate cut by the US Fed spawned a flicker of hope back home here that the Reserve Bank would at least tone down its strident policy stance, what happened in Israel Tuesday night has completely put that little flicker out given the scale of escalation in the world’s most volatile region that’s also is the fuel capital of the world, and the way crude prices reacted-- over 5 per cent jump immediately after the newsbreak and another 3 percent Wednesday, taking the Brent past USD 74/barrel.
To be sure, nobody was expecting a rate cut on October 9 under the just-reconstituted. Many were of the view after the last policy wherein for the ninth time, the rates unchanged at 6.5 per cent, the Reserve Bank may begin to tango with the rest of the world from the December policy or latest by February. And then the governor repeated thrice that inflation is still not tamed. But that was before the whopping 50 bps rate by the Fed—third time in its history. But that again is behind us with the escalating tension in the Middle East.
Unlike last time when it delayed the appointment of the external members, which was to happen on/before September 26, the government Tuesday appointed Prof Ram Singh, a director at the Delhi School of Economics; the economist Saugata Bhattacharya; and Dr Nagesh Kumar, the chief executive of the Institute for Studies in Industrial Development, New Delhi as the new external members with immediate effect. Though the term of the incumbents Ashima Goyal, Shashanka Bhide, and Jayanth Varma, is up to October 4.
Significantly, like their predecessors, the incoming ones also assume their charge amidst rising geopolitical tension and the resultant impact on oil prices and thus inflation which has been ebbing for a while and remained under the sensitive 4 percent in July and August, leading to optimism that the Mint Road may relent on its anti-inflationary stance at least.
The optimism was also spawned from the fact that other major central banks such as the European Central Bank and Bank of England, and their emerging markets peers have also moved towards easing monetary policies and have promised to embark on an easing cycle. Only Bank of Japan stands out, increasing the rates.
The tension escalated in the Middle East after Iran fired close to 180 ballistic missiles into Israel last night, which was met with a strong warning from Israel that Tehran will have to face much fiercer consequences.
While Iran accounts for just 4 percent of global oil output, the region as a whole led by Saudi Arabia and Iraq controls nearly 45 percent of global supplies. And given the centrality of the area for global oil supply, crude shot up immediately and is hovering over USD 74 a barrel now.
India being a net importer of oil and gas—to the tune of 85 percent annually--any price flare up will lead to inflationary pressures and deeper current account deficit, which in the past quarter widened to 1.1 percent, from a surplus in the previous quarter.
Though fuel has weight of only 7 percent in the CPI basket, risk of fuel prices passing through to the domestic consumption basket remains a key concern. Because, a USD 10 per barrel rise in crude prices can typically raise CPI by 10 bps, given our massive dependence on imported oil and can increase the current account deficit by 30-40 bps.
There is also fear that the conflict may snowball into a wider regional war that can alter the trajectory of interest rates globally. Another collateral victim will be the rupee, which has been under stress for long and had tested the 84 mark last month.
In a note Fitch Solution has said “a full-blown regional war in the Middle East is the biggest downside risk to our rupee forecast, as it will cause a spike in oil prices and turn the markets off-risks.”
This comes on the heels of its recent forecast for the rupee strengthening to 81.5 to the dollar by December and further to 80 in 2025 as yield differentials move in its favour.
Though the Israel-Hamas will be one-year next week (October 7) the current level of tension is a new source of shock. Hence, with the focus shifting to external risks, the RBI is set to turn cautious and respond in a calibrated manner to global turbulences as the strong economy can face hiccups from this crisis.
While leading economists are still assessing the impact, Care Rating in credit report quality report, prepared earlier but released today, said on the monetary policy front they anticipate that the RBI may initiate a shallow rate cut cycle in the second half of the fiscal year if food inflation remains at comfortable levels. But now all these depend on the impact of the geopolitical risks, especially the escalation of the conflict in the Middle East.
The ongoing geopolitical uncertainties and energy price volatility will have repercussions, if our forex reserves were low. Given the sufficient reserves, the instantaneous repercussions will be negligible. The record rise in foreign exchange reserves will helps insulate the economy from macroeconomic uncertainties from such global shocks, according to Lekha Chakraborty of National Institute of Public Finance and Policy.
If the current flare up leads to an all-out war in the Middle East it could sharply raise oil prices and intensify supply disruptions. This poses a risk for our current account, rupee and inflation, said Sakshi Gupta, principal economist at HDFC Bank.
Paras Jasrai, an analyst with India Ratings said so far oil price has been because of low demand from China a further escalation can take oil beyond USD 90/barrel it can widen the current account deficit to around 1.5 percent and the resultant pressure on rupee and thus the inflation.