Wednesday, April 17, 2013

Falling oil and gold doesn't mean we are out of the woods
It is too early to celebrate the decline in oil and gold prices. Reason: while this will benefit the current account deficit (CAD) and lower the prospects for further fuel price inflation, the critical question is what happens to the rupee. If the rupee stays weak, or it declines, then all bets are off.

At the time of writing, Brent crude was at $100 a barrel, the rupee just under Rs 54, and gold was quoting below Rs 24,000 per 10 gm. All this is good news, but they do not add to a positive story overall. Here’s why.
A high CAD – the gap between what the country spends abroad and what it earns from exports and remittances – is one reason why the rupee has been under pressure since 2011. When the rupee falls, imported oil gets pricier even if the global price of crude falls – as it is doing now. Hence what matters to us is not just the price of oil or gold, but the value of the rupee which determines local prices of these commodities.
The rupee, in turn, depends on the level of CAD and the state of capital inflows. A high CAD pressures the rupee down. CAD itself depends on two things – the level of imports and exports, and net inward remittances. Falling imports are a signal that CAD could improve, but if exports fall in tandem, relatively we will remain in the same place.
Capital inflows, on the other hand, will depend on several factors – from the attractiveness of competing investment destinations outside India to domestic interest rates (the higher the rates, the more the inflows), political uncertainties (the greater the uncertainty, the more the reluctance of foreigners to invest in India), and the related policy environment, among other things. Portfolio flows depend on the short-term prospects of the stock and debt markets, and expectations on the rupee, and long-term foreign investment flows (FDI) depend on policies.
Right now, political uncertainties are rising, and interest rates are set to fall as growth stumbles. The US stock markets are already at highs, and if they start falling, the sentiment could affect Indian stocks, too, and lead to a selloff. Year-to-date, India has already attracted over Rs 63,000 crore in foreign portfolio flows into equity and debt, and further inflows depend on prospects elsewhere, and not just here.
In short, since all variables impact all other variables, it is not possible to make a linear deduction that since oil and gold prices are falling, the CAD will improve and hence both the rupee and inflation will stabilise.
As for gold, the less said the better when it comes to India. Will Indians buy less gold if it is cheaper, or more? A lot will depend on whether we think gold will fall further, in which case we will wait and watch. But if we think it is cheap enough, we will buy more. If this happens, it would mean that the full extent of the CAD gain from falling gold imports will be lesser than expected.

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