The hike in fuel prices, twice in one week, after nearly four years is garnering plenty of attention as a means to stem India’s dwindling forex reserves. How will the domestic price hike in petrol and diesel help India’s economy at large? HSBC Securities and Capital Markets India says the price hikes can help India cover two-thirds of the total FX reserves challenge.
Along with that HSBC highlighted that structural reforms and stronger capital inflows will be needed to address medium-term external vulnerabilities due to elevated crude oil prices and a weakening rupee. Here is what the macroeconomic picture looks like for India so far, according to HSBC.
CAD may widen to 2.3% in FY27, BoP deficit of $65 billion: HSBC
HSBC estimates that India’s current account deficit (CAD) could widen sharply to 2.3% of GDP in FY27 from 0.9% in FY26 if oil prices remain elevated and external risks intensify. Crude oil prices are hovering near $110 per barrel due to the prolonged supply disruption via the Strait of Hormuz, an essential global supply route.
“We estimate that for every 10% rise in global oil prices, the current account deficit widens by about 0.3% of GDP. This 40% rise in oil prices can then add 1.2 percentage points to the CAD, taking it to 2.3% of GDP in FY27 ” HSBC said.
India’s BoP deficit may widen to $65 billion in FY27
Assuming crude oil prices will average $95 per barrel in FY27, HSBC also said that India could face a balance of payments (BoP) deficit of nearly $65 billion in FY27 from $35 billion in FY26.
HSBC said that India is addressing two challenges: “First, a short-term problem of elevated energy prices, which threaten to widen the CAD, and second, a medium-term problem of capital inflows slowing, which pushed the BoP into deficit even before the energy shock struck,” HSBC said.
India may need $30 billion extra FX reserves: HSBC
HSBC said periods of Balance of Payments (BoP) stress can be managed better when a country has strong foreign exchange (FX) reserves, as they act as a cushion against external shocks. Based on traditional reserve adequacy indicators, India’s FX reserves currently remain at comfortable levels. India currently holds around $594 billion in net FX reserves.
However, factoring in the $65 billion BoP deficit for FY27 could weaken India’s reserve adequacy metrics and the country may require an additional $30 billion in FX reserves to remain above historical stress thresholds through FY27.
Petrol, diesel price hikes can ease India’s external pressure: HSBC
HSBC said that India needs to maintain adequate external buffers to arrange the additional $30 billion in FX reserves and this is where higher domestic oil prices play a role.
Higher petrol and diesel prices could help narrow the trade deficit by reducing oil demand and lowering the import bill.
“There is evidence from 2022 that adequate increases in diesel and petrol pump prices can meet nearly two-thirds of the additional funds required,” HSBC said.
According to HSBC, India’s oil import bill declined by nearly $20 billion in the following year after fuel prices were raised in 2022.
India-EU trade deal can revive FDI inflows: HSBC
HSBC said quickly operationalising India’s recently signed trade agreements could help revive gross FDI inflows. It expressed optimism over the potential benefits of the India-European Union trade agreement finalised earlier this year.
The brokerage further recommended rationalising tax treatment across asset classes and making India’s foreign investment taxation more competitive to deepen markets and attract sustainable capital inflows.
Conclusion
HSBC said that due to the weakening rupee and surging oil and fuel prices triggered by the Middle East war, India faces “a two-fold challenge: a widening CAD and attracting capital inflows” to keep the economy on a sustainable path. The brokerage recommends policy measures, including raising fuel pump prices.