With oil prices going higher, do you see the chances of the rupee weakening from current levels?

In the last few weeks, crude oil has been on a run. For example, on Friday, the Brent crude price crossed the $50/bbl mark which is the highest level for oil in over 10 months. The rally was largely on the back of the COVID vaccine and the hopes of a global economic recovery.

However, this rally in oil has opened up two major risks for the Indian economy at a macro level. The first risk is the probability of a widening trade deficit on the merchandise account. Exports are already struggling to grow, so trade is an issue. The second big risk is the chances of a steep depreciation of the Indian rupee.

Now we have seen in the past that the rupee value normally tends to be very sensitive to the price of oil. That is more because, India relies on imports to meet 85% of daily oil needs. Since India has got tremendous refining capacity, heavy imports of oil will surely end up pushing the trade deficit higher.

But there is some room for hope too. Rupee got some support at around the Rs.74/$ level from the FIIs infusing Rs.16,000 crore during the previous week into the Indian markets. These sharp inflows has not only lifted markets and market sentiments but have also enhanced the forex reserves of the RBI.

That is the second reason to be smug. Forex reserves are edging closer to $580 billion and the RBI has enough fire power to hold the rupee if required. The only worry is that local inflation will be hit as the Indian government used every dip in crude prices last year to enhance excise and increase its revenues. So higher prices have to be passed on.