Threat of 'imported inflation' looms as oil prices jump to $62/barrel

The sudden flaring up of oil prices to $62 a barrel will threaten the Indian economy as the impact can be severe for currency, foreign exchange reserves, inflation and interest rates.

1. Trade Deficit To Widen

Higher oil prices are not a good thing for Indian economy as the country imports 80 per cent of its crude oil requirement. In fact, the oil has a 20 per cent share in total imports. The rising prices could easily translate into higher import bill and consequently higher trade deficit if the export doesn't back up. In fact, India runs a trade deficit for many decades. The trade surplus was last seen in 1976-77.

2. Current Account Deficit

India has managed to contain the current account deficit (CAD) in the period after 2012-13 when it was 4.8 per cent. But the trend was reversed in the first quarter of 2017-18 when CAD moved from 0.7 per cent in 2016-17 to 2.4 per cent in the first quarter of 2017-18. The country's economy so far was saved because of lower oil prices or imports and sustained inflow of dollar into Indian equity and debt market. But if the CAD widens, there will be implications. The Indian rupee value has been quite stable post September 2013 when the RBI announced a slew of measure to boost the rupee value.

3. Higher inflation

The higher oil prices will have a direct impact on the inflation numbers. The CPI or retail inflation is already showing signs of strengthening. The CPI closed at 2.89 per cent in September. The higher import duties, targeted at protecting Indian industry, also has an inflationary impact. There will be a double whammy if the rupee also depreciates. A higher inflation and lower growth will have much larger implication.

4. Interest rate cycle to reverse

The interest rates have almost bottomed out because of higher retail inflation. But if the inflation goes up because of higher oil prices or because of a rupee depreciation, the economy, which is already under pressure, will have a new problem at hand.

5. Foreign reserve kitty

While India's foreign exchange reserves at close to $400 billion are a no match to China's $3 trillion or Japan's $1.3 trillion. A depreciating rupee will impact the future portfolio inflows into the country.