No easy time for Dollar-Rupee & GOI bonds

After testing an all time low at 74.4825 on October 11, 2018, the Indian rupee has started recovery mainly due to the decline in crude prices. The rupee closed at 69.77 levels against the dollar in the last trading session of the year witnessing a fall of Rs 5.90 or 9.24 per cent on a year-on-year (YoY) basis from its 2017 year-end level of 63.87.

In 2018, the US emerged as the world’s biggest oil producer pumping 11.6 million barrels per day of crude more than both Saudi Arabia and Russia. Concern over oversupply of crude and slowdown in the global economy widely contributed to the fall in prices. The decline in oil prices had helped the Indian rupee to shrug off its weakness and made India a more attractive investment destination in the last three calendar months of 2018.

Will this favourable scenario for India continue in 2019? A provisional estimate of the OECD shows that the real GDP growth of G20 countries eased to 0.8 per cent in the third quarter of 2018, from 1 per cent in the previous quarter. Can we expect crude oil price to hover near the $50 per barrel mark for a major period of 2019 due to the growth slowdown worries in the largest economies? Is there any factor, other than oil prices, going to influence USD/INR rate in 2019?

Crude prices

According to me, the following factors are going to set the rupee exchange rate and GOI bond yield in 2019: Direction of crude prices; strength of macroeconomic balance sheet of ours; underperforming export sector; response of RBI towards transferring excess reserves to the government and post election structure of our next federal government in India.

Oil always remained a major commodity to set the direction of Indian economy due to our high dependence on its import. A sharp rise in oil prices may change the current feel good factor for the

rupee. To ease the supply worries the OPEC and its allies, including Russia, agreed earlier to cut oil production by 1.2 million barrel per day with effect from January 1 in the new year. The market will start to feel the price effect of the cut from the second week of the current month.

Since economy of OPEC was adversely affected by the lower oil price, they may try to offset the fall in demand due to slowdown in the global economy by a fresh cut in production to balance the market if the current cut fails to drive the price higher as per their expectation. Despite a decline in market share, OPEC and Russia together is estimated to produce 48.95 per cent of crude in 2019 in comparison to 19.24 per cent from the US. Saudi Arabia has already reduced its crude shipments to the US to bring down their crude oil inventories, a closely watched indicator by the market participants, to signal tighter supply in the market. Market forecast of an average Brent price of $69.13 per barrel in 2019 against an average real price of 71.76 in 2018 indicates huge volatility in the oil market within the price band of $60 and $80 per barrel.

The government is likely to miss its fiscal deficit target of 3.30 per cent of GDP in the current fiscal. GST collection of Rs 3.41 lakh crore in April to December 2018 is far short of budgetary estimate of Rs 6.04 lakh crore and very unlikely to cover up the shortfall in the last three months of the financial year 2018-19. Big slippage is expected in the revenue collection and expenditure control as well, ahead of the Lok Sabha polls. Expected higher oil price from the current low, populist pressure in budget proposals and possibility of extending financial support to farmers countrywide, on the back of dismal performances of the ruling party in the centre in recently concluded assembly elections in five states may further increase fundamental weakness in our macroeconomic balance sheet.

From April to November, 2018 our trade gap has sharply increased to $128.13 billion from $106.37 billion a year earlier. In this scenario, an orderly depreciation of rupee is highly desirable to increase export competitiveness and which may relieve some concern on fiscal balances. A combination of rising demand in US and Europe with a competitive exchange rate in USD/INR is expected to help India on the trade front.

Ahead of probable uncertainties in election outcome, the market is expected to witness bigger exit from funds by the foreign investors who are waiting for the right opportunity on fear of a slowing global economy. All the factors as stated above, pointing towards a highly volatile Indian market in all segment of trading in 2019 where USD/INR may re-visit earlier high of 74.4825 with a possibility to touch 78 levels before the end of the year and 10 year GOI benchmark yield may hover near 8.00% in many trading sessions during the calendar year. So, Indian rupee and GOI bonds may not have happy time in the ‘Happy New Year 2019’.

(The writer is a former general manager of a public sector bank)