The last three weeks have seen the collapse of oil. Prices have fallen to 2018 lows and more falls may be on the cards. This has meant a stronger rupee and a favourable reassessment of external macros. But there are different worries associated with a possible reduction of global growth rates.
On the domestic front, there has been a patching up, perhaps only temporary, of the relationship between the Reserve Bank of India (RBI) and the government. Low GST collections imply that the government will either have to cut expenditure sharply or let the fiscal deficit expand. There are also worries that rural demand may have fizzled, given a scenario of widespread agricultural distress.
Most of all, concerns centre on political continuity. The Assembly elections across the three major BJP strong holds of Rajasthan, Madhya Pradesh and Chhattisgarh are seen, rightly or wrongly, as bellwethers for the Lok Sabha elections. The BJP won 61 out of 65 Lok Sabha seats in those three states in 2014 as well as sweeping assemblies in 2013. A poor showing in the assemblies would lead to selloffs.
The crude scenario has seen a stunning turnaround in November, with prices falling from October peaks of $86/ barrel (Brent) to current levels of $60. The Indian basket traded at $80 in October and at an average of $74.5 for April-October 2018. It was down to $63 in November. It averaged $56-57 in 2017-18 when the current account deficit was 1.9 per cent of GDP. Analysts are reworking assumptions related to crude and Current Account, with consensus suggesting a CAD of 2.6 percent.
The geopolitics of oil are very complicated. The Organization of the Petroleum Exporting Countries may cut production by several million barrels at its December meeting. That could shore up prices . There is the imponderable of US production. About 30 per cent of US production, almost all of it shale, came after oil prices crossed $65 and the median cost of US production is $46/barrel. Shale can start up or shutdown in 4-6 months. It Is entirely possible that major US production cuts will occur if crude prices don’t rebound. Again, that may put a floor on prices. Flaring tensions between Russia and Ukraine could also have an impact if Putin uses the energy leverages he possesses, versus Ukraine, and the EU.
Energy prices have collapsed due to fears of oversupply if global growth slows. That would be a poor scenario for exporters and it’s important to note that crude prices are extremely unlikely to revert and stabilise much lower than the current levels.
December will see important monetary policy reviews from multiple central banks. The US economy continues to grow quickly and inflation is high, with government bond yields having breached 3 per cent. The Federal Reserve is likely to hike the Fed Funds rate and continue to “quantitatively tighten”, to reduce its balance sheet. The EU is supposed to start tapering its bond-buying QE programme but it may hold off, given slower growth and Brexit. The Bank of Japan already has a balance sheet that exceeds Japan’s GDP. It might, at maximum, maintain the ongoing QE. Net-net, that should mean tightening of global liquidity.
The RBI’s Monetary Policy Committee has a conundrum. It is hard to justify rate hikes on the basis of the current consumer price index, which is running at 3.7 per cent (October). But core inflation, excluding food and fuel, is at above 6 per cent and the wholesale price index is at 5.3 per cent. If hard currency flows tighten and hard currency yields rise, the RBI will have to tighten or it will have to be braced to spend another large chunk of reserves to defend the rupee.
The RBI Board meeting next month is also likely to be contentious. The central bank has given ground, granting an extra year for banks to meet Basel-II norms and thus, relenting on CRAR limits. It’s also likely to see its independence trammelled if the proposed committee reviews the limits of the RBI’s autonomy. There is also likely to be continued pressure to loosen prompt corrective action norms. One good thing is that high-rated NBFCs have managed to rollover outstanding loans in November, albeit at higher yields. The IL&FS mess has been contained, at least for now.
Headline inflation is trending down, due to negative moves in food prices. That implies rural distress — the massive farmer’s rallies confirm this. Demand slowed during the festive season, going by massive unsold automobile inventories. This gels with low GST collections as well.
GST collections are running well below Budget estimates. The government might collect Rs 500 billion less than budgeted for 2018-19. As of now, disinvestment is about Rs 650 billion short of target. Expect the fiscal deficit to rise well beyond the targeted 3.3 per cent of GDP, or expenditure to be cut drastically — the latter looks unlikely in an election year.
The Q2 results indicate that metals and mining did well but there weren’t many other sectors with great results. The energy turnaround could change equations for Q3. Technically, the market is in watch-and-wait mode. Domestic institutions have been sellers in November while FPIs have come back but trading volumes are quite low.
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