Rising oil prices spell trouble for India on the current account deficit front

The rise in international crude oil prices has spilled over into the October-December quarter, potentially leading to a higher current account deficit (CAD) for India and increased pressure on the rupee. The Israel-Hamas war has added further uncertainty to crude oil prices and the global economic recovery.

A country experiences a current account deficit (CAD) when the value of its imports of goods and services exceeds its exports. This weakens the macroeconomic fundamentals of an economy and increases volatility in the local currency.

India imports nearly 85% of its crude oil requirement, and any increase in global prices leads to a rise in the import bill. Since large payments in dollars are required to purchase crude oil, the rupee’s value decreases compared to the American currency. A weaker rupee makes imports even more expensive as more local currency is needed to buy dollars.

Crude oil prices have begun to rise again and are currently around $86 per barrel. Oil prices increased by almost 30% in the three months leading up to September, marking the largest third-quarter gain in nearly two decades. The benchmark Brent crude recently reached a staggering $95 per barrel.

As rising crude oil prices on the international market increase the demand for dollars, the Indian rupee has fallen to record lows below 83 against the US dollar.

India’s merchandise export earnings, which have already started to decline, could suffer further due to geopolitical turmoil affecting the global economic recovery. Leading software services exporters in the country, including TCS, Infosys, and HCL Tech, have also revised their revenue guidance for the next quarter.

The country’s current account deficit (CAD) surged 7-fold to $9.2 billion in the April-June quarter compared to $1.3 billion in the previous quarter, according to the latest data released by the RBI last week. With oil prices continuing to rise and exports slowing down due to reduced demand in global markets, this deficit is expected to widen further.

The CAD for the April-June quarter of 2023-24 was 1.1% of GDP.

According to Madhavi Arora, lead economist at Emkay Global Financial Services, the July-September quarter will witness a “significant widening of CAD” to 2.4% of GDP due to higher oil prices, increased core imports, and further decline in services exports.

Future outcomes will heavily rely on oil prices in global markets.

The RBI has been releasing dollars into the market to support the rupee, but this has not been able to halt the decline of the Indian currency. As a result, the country’s foreign exchange reserves decreased in September.

According to RBI data, India’s forex reserves fell for the third consecutive week to a four-month low of $590.7 billion as of September 22. The reserves decreased by $8.2 billion in three weeks.

The decline in foreign exchange reserves is a matter of concern as it limits the RBI’s ability to control rupee volatility through market interventions. Petroleum Minister Hardeep Singh Puri has also expressed concerns about oil prices. “If crude oil prices rise, it will have a strong and adverse impact on global economic recovery… Hopefully, we will be able to navigate through these challenges. But speculation on this matter is not advisable,” said the minister.