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July 30, 2018

CRISIL Insight: Ring, Fence

How fit is India to fend off 1-2-3 punches?

In January this year, we highlighted a troika of looming global risks, with implications for India. Two of these – asymmetry in monetary policies in advanced economies and elevated oil prices – have since manifested. The third – trade wars – has moved from rhetoric to action.


In this sequel, we examine how these risks have advanced and assess how prepared India is to brave them.


The chinks are showing already.


Since the start of 2018, foreign investors in India have fled debt and equities. Trade deficit has swelled and precipitated a fall in the rupee. All this, tangoing with the trend in other emerging markets.  The impact of external shocks depends on their magnitude and the economy’s ability to face it. While the oil price shock is a known devil with perceptible impact on current account deficit (CAD) and inflation, we are still struggling to get a hold on the other two, which do not have much precedence.


The most prominent and inevitable risk of these shocks is on CAD and its financing. Since India is a net importer of oil, higher oil prices straightaway fuel the merchandise trade deficit. Besides, the trade wars (by pulling exports and/or pushing up the import bill) could widen the non-oil trade deficit which is already at levels higher than in fiscal 2013, when the CAD was at its peak.


The rupee inevitably gets swept by the next wave of risks. If CAD were to balloon, the rupee would face depreciation pressure. To boot, it could display high volatility given the triangulation effect of elevated crude oil prices, trade wars, and increased dollar demand, while monetary policy normalisation in advanced economies could stoke capital outflows from India. However, we expect the rupee to stabilise towards the end of this fiscal to average 67 per dollar in March 2019 compared with 65 in March 2018.


Consumer price index (CPI) inflation has been witnessing some pressure from rising crude oil prices but the pass through is still incomplete. We’ll have to wait and watch how second-round effects enter headline inflation in coming months.


Overall, gauging the impact of these shocks is not very straightforward as these transmit through multiple channels, and over an extended period of time. Besides, most of these shocks are evolving, which makes it all the more difficult to decipher how they will pan out.


Though most of India’s macro parameters have seen some strain lately, they also appear resilient when compared with the 2013 ‘taper tantrum’, and in better shape than other emerging markets to negotiate the latest onslaught of global risks.