RBI’s forex reserves to help India ward off oil shock: Indranil Sengupta, CLSA

In the recent report you have said that this time, the oil shock is much more manageable versus earlier times. Why so?
The geopolitical risks, especially the oil shock, is getting overdone for the Indian economy. We take a scenario where oil goes to $150-200 a barrel for two months because of the war that is going on and then subsides because once the war is over or in the next 10-15 days, the market will also begin to look at Fed tightening. We also assume that you get $20 billion of FPI outflows – $4-$5 billion of which has already happened because of the extreme risk aversion that we are seeing. So we are effectively looking at a forex outflow of $30-50 billion at a time when the RBI has sufficient Fx reserves.

So if the RBI’s forex reserves are around $680 billion including forwards, we think $600 billion is adequate and so RBI has $80 of billion of excess reserves with which it can easily fund these outflows of $30-50 billion that might take place. So from that perspective, whenever we had an oil shock earlier, we did not have forex reserves and had to go to the IMF. We are in a far better situation now.

So we are much better placed as far as forex reserves are concerned. The worst as far as the FPI outflows is not done. That is the word coming in. What do you think this does to the rupee as well as the bond yields? It is now trending towards the 7% mark?
We think the rupee should be in the 73 to 76.50 range for the year. Given the uncertainty all around, it is for the RBI to draw the laxman rekha (boundary) for the rupee which currently seems to be around 77 because obviously this is a central bank with very high forex reserves and it has to choose where it will draw the line, where it will defend the rupee and so on. So that is point number one.

Number two, we always thought that yields would go to 7%, irrespective of the war much long before the war because you know you have a very high fiscal deficit which means that there is an excess supply of G-Secs in the market and the RBI should be hiking at least 100 bps next year. We think that ond yields should be around 7% now and 7.5% in the coming year irrespective of the war.

Crude oil prices have gone up and you know all of them coming together but you think that market so far have taken it I mean investor have so far taken it maturely, Indian markets have broadly outperformed the fall versus some of the others you think all of the factors that you said about reserves the changes that have happened, the rate hike that are expected are all playing to that sort of momentum in India?
I think the best defence India has against global contagion now is the high forex reserves which anchor the rupee. If we go back to previous episodes when we did not have sufficient forex reserves between let us say 2010 and 2020 and often saw the rupee depreciating 10%-20%. So, that is a thing of the past and that is helping to some extent right now and should continue to provide a shield for the Indian economy.

Going into December 2021, we saw all economists’ reports talking about how a structural recovery across India may be not led by consumption, but by assets and investments into capex. Do you think with oil prices shooting up, that recovery could take a back seat because the consumption will take a hit?
We have talked of a structural recovery. We were always in the camp that there is a shallow recovery. Demand is an issue and because demand is an issue, capex also will take time to recover. We are looking at 7.4% GDP growth rate next year. If one looks at the impact on inflation, for example 100 on an average basis for the year, we are talking of 50-60 bps of additional inflation.

Forecast of inflation for the entire year is 4.7%. If we touch 5.3-5.5%, it is not that excessive. Again like I said, yields will probably go up to 7.5%. There is no great reason for the RBI to step up tightening because of oil going up. I do not see the higher oil prices affecting growth. Growth has other issues. The fact is consumption demand is weak and there is excess capacity, because of which investment is not happening.

You are saying higher crude price might not impact growth. But will it impact the margins of the companies? Are you expecting more downgrades to happen in the coming time and has the Street already factored in the worst as far as margin compression is concerned?
We have been factoring in margin compression not just because of oil prices but also because of what is happening in the palm oil market as well for a number of consumer companies and what is happening in the other commodity prices as well.

But the commodity space is being driven by war. So in a way, we would think that once the war is over, a lot of this will abate and the Fed tightening will start. So, commodity prices would be lower six months to one year from now than higher.

What is your take regarding the impending Fed meeting which is coming up next week? What is your expectation and house view?
We are looking at a 25 bps hike by the Fed and six hikes this year in all.