Higher oil prices or oil taxes hurt discretionary spend when the economy is recovering from the Covid’ 19 shock. BofA Securities estimates that an increase in $10 per barrel can potentially reduce consumption by 0.4 per cent of GDP and a 10 per cent change in oil prices impacts inflation by 23bps or basis points (one bps is 0.01 per cent).
“We expect the RBI MPC to remain on hold in FY’22, with oil prices rising, and hike rates by 100bps in FY’23” said Indranil Sengupta, chief India economist, BofA Securities and his team. Currently the benchmark policy rate- the repo rate is at 4 per cent.
The economists expect some fiscal policy support to rein in oil inflation through oil tax cuts. “We continue to expect an oil tax cut to soften retail prices”m they said. An oil tax cut may reduce prices by Rs10/litre, but also impacts the fiscal deficit by 0.6% of GDP. Besdies, it could raise the current account deficit by around $ 9 billion. This poses an upside risk to BofA Securities’ current account deficit forecast for FY’22 at 0.5% of GDP assuming oil at $50/ barrel.
But this deficit can be funded by RBI’s open market operations (OMO) as the higher oil import bill will cut foreign exchange market intervention, according to the economists “In our base case, we forecast $39bn of OMO in FY’22 combined with 2-3 year LTROs at a 3% hike in banks’ HTM limits, extended to FY’26” a BofA Securities’ report said. High forex reserves would also limit the rupee impact of higher oil prices.