By Preeta George & Chinmay Joshi
The Reserve bank of India in its recent announcement on July 11, 2022, has allowed domestic traders to settle their import and export bills in Indian Rupee. This is a bold but effective move aimed at arresting the ongoing volatility in the foreign exchange market and its impact on the value of the rupee. India is a prominent nation among the Emerging Markets and Developing Economies (EMDEs), not only in terms of the geographical area it occupies but also in terms of the size of its population. India’s huge energy requirements are thus inevitable.
India imports more than 80% of its oil requirements from abroad. The fluctuations in the international energy prices, especially crude oil prices, has a significant bearing on India’s import bill given that Petroleum and Oil (POL) forms a considerable portion of India’s trade deficit. (Table 1)
Data from Table 1 show that in the last decade, India’s trade balance is hugely impacted by the import of energy products. For instance, in the financial year 2013-14, POL recorded a share of around 69% of total trade deficit whereas in the last financial year this figure hovered around 50% of total trade deficit. In majority of the years in the last decade, the share of oil and petroleum products has been more than 50% of overall trade deficit for India, implying the potential or capacity of the energy import prices to influence the trade balance of India which would further have significant implications for India’s current account and overall balance of payments situation.
Recent scenario of brent crude oil prices and INR-USD
Indian currency has been persistently depreciating against the US dollar since the start of the current financial year. Rupee touched an all-time low of around Rs. 80.00 per US dollar in the intraday trade and settled at Rs. 79.98 per US dollar on July 18, 2022 only to recover marginally after RBI’s intervention. As per the Reserve Bank of India (RBI) data, as of end July 2022, the Indian currency has witnessed a depreciation by around 5.11% against the US dollar in the current financial year. One of the major reasons behind the recent currency depreciation is rising crude oil prices among others. Other vital reasons being huge capital outflows from India as a result of possibility of further fed funds rate hike by the US federal reserve in its upcoming FOMC meetings, uncertainty created by the ongoing war in Eastern Europe, and a gloomy outlook for global economic growth. In the current financial year, till the early start of July 2022, brent crude oil prices rose and remained at an elevated level, whereas commensurate depreciation of the Indian currency against US dollar can also be observed during the same period. (Graph 1)
A heavy burden on FER
For any country having an enhanced dependence on trade and more so for an essential commodity like oil, for its economic growth, the foreign exchange reserves serve as an armour to shield the economy from the risks associated with currency depreciation and external debt defaults. India’s foreign exchange reserves have been consistently declining in the recent past. As per the Weekly Statistical Supplement released by the RBI on July 29, 2022, India’s foreign exchange reserves declined by 1.152 US$ billion as on week ended July 22, 2022 and recorded at a level of 571.560 US $ billion. In the previous reporting week i.e. week ended on July 15, 2022, India’s foreign exchange reserves declined to the tune of 7.541 US $ billion due to the volatility in the foreign exchange market. This is in contrast to India’s foreign exchange reserves of 639 US $ billion in September 2021.
RBI’s move – A step in the right direction
The internationalisation of the rupee will certainly act as an additional tool along with the use of foreign exchange reserves in arresting the volatility in the foreign exchange market. India will also be able to save significant amount of its precious foreign exchange reserves for the exigencies caused by the sudden capital outflows due to the reasons such as rising international crude oil prices, exacerbating situation in Eastern Europe due to Russia-Ukraine conflict and possibility of further hike in interest rates by the US federal reserve to arrest the rising price levels in USA etc.
Trade of oil in rupee terms is expected to help control rupee depreciation and inflation caused by fluctuating oil prices. Hence, it will be beneficial for a country like India which has huge energy requirements to reduce the strain on its trade and current account balance caused by volatile international crude oil prices.
One of the other major benefits which India will be able to gain is diversification of partner countries from which it imports crude oil. Importing crude oil in increasing quantities from various other non-traditional partners using Indian currency will help reduce reliance on traditional partners. Data sources indicate that, till the previous financial year, the top oil exporter to India was Iraq followed by Saudi Arabia. Iraq had share of around 22% in 2020-21 while Saudi Arabia had share of around 17-18% in the past decade. Now USA has also made it to the list of top oil exporting nations to India with the growth in production of shale oil. Apart from above countries, Russia, Iran, Venezuela, Nigeria and the UAE remained the top countries exporting oil to India. As per the new RBI guidelines, India will be able to settle the energy import bills from countries such as Iran, Russia and Venezuela which were facing the western sanctions.
Long term and sustainable solutions
Though the above measures are effective in dealing with the current onslaught on the Indian Rupee, it provides for and are meant to be only for the short term and may not be sustainable in solving the more structural and deep rooted causes. India being a country which is largely dependent on import of oil and other energy products for its huge energy requirements, will have some respite on its current account front as it will be shielded from the volatility in the international crude oil prices. However, it is also imperative to reduce its dependence on imported oil and oil products. India should try to tap more domestic oil resources and encourage investments in research and innovation in exploring domestic energy resources so that the dependence on imported energy products can be reduced. The government’s efforts towards the use of renewable sources of energy can definitely be a game changer.
India should also diversify its oil sources as discussed above from its traditional oil partners such as Iraq, Saudi Arabia, UAE and other OPEC nations to countries such as Iran, Russia and Venezuela which have been put under sanctions by the US and its allies. Each and every nation has a right to safeguard its own interest in the international political and economic arena. RBI as a custodian of the India’s foreign exchange reserves has taken a proactive and meaningful step to safeguard the interest of the Indian economy which by all means should be welcomed. RBI is right and justifiable in withstanding the pressure caused by the imposition of sanctions by the US and other western nations as in this Darwinian evolutionary world, only the fittest can survive.
(Preeta George is a professor, and Chinmay Joshi is an Academic Associate at Bhavan’s SPJIMR. The views expressed are the author’s own. Please consult your financial advisor before investing)