From high crude prices to depreciating rupee: What are the biggest risks to India's growth?

NEW DELHI: Higher oil prices, slowing global demand for India’s exports, and inflation are acting as the biggest drag factors for not only India's equity markets but also the country's growth prospects.
Higher inflation reduces purchasing power and impacts revival of consumption- which is the largest component of India's gross domestic product. "We foresee the consumer price index (CPI)-based, or retail inflation rising to 6.8% on average this fiscal, compared with 5.5% last year. The impact of this year’s heatwave on domestic food production, coupled with persisting high international commodity prices and input costs, will cause a broad- based rise," said Crisil rating in a report.
Add to that elevated commodity prices due to the ongoing Russian-Ukraine war.
The seemingly unending Russia-Ukraine war has wreaked havoc in commodity markets. While freight costs have moderated, they are still elevated when compared with the beginning of this year (pre-war). "This seems to suggest that a continuing war will prevent any meaningful correction. For India, this translates to higher import bills and higher inflation. At the same time, global growth projections have been lowered, signalling a drag on India’s exports," noted the Crisil report.
Also, ‘stagflation’ is looming large, as global central banks use rate hikes to tame inflation.
What’s getting India's growth down?
The war is severly impacting energy and food supplies
The Russia-Ukraine war has dealt a severe blow to both energy and food supplies. Energy prices are projected to rise over 50% this year, and non-energy by 20%, according to the World Bank’s latest commodity outlook.
Crude oil, of which India is a major importer, is expected to average $105-110/bbl this fiscal, up 35% over last fiscal, and the highest since 2013, noted Crisil.
According to the World Bank, “the increase in energy prices over the past two years has been the largest since the 1973 oil crisis and price increase for fertilizers, which rely on natural gas as a production input, have been the largest since 2008.”
Now, high commodity prices have a domino effect on India. As the terms of trade worsen with a rising import bill, imported inflation surges.
"Between April and January in fiscal 2022, we assess that imported inflation accounted for as much as 60.9% of the wholesale price index (WPI)-based inflation," said Crisil.
Inflation
Crisil expects consumer price inflation (CPI) inflation to rise to 6.8% on average this fiscal, from 5.5% previous fiscal. This would be the highest level in 9 years, and above the RBI’s target range of 2-6%.


Unnatural heatwave impacted production of several foodgrains, vegetables and spices this year, including major ones such as wheat and tomatoes.
Wheat supply is particularly tight. The third advance estimate for the year revised down wheat production by 4.4%, pegging it at 106.4 million tonne (MT) in fiscal 2022, the lowest since fiscal 2019.
Rice stocks, however, are more comfortably placed.
"The easing of food prices will, among other aspects, depend on the quantum and spread of the monsoon. A normal monsoon could help ease prices in the second half. However, its intensity and distribution will have an
important bearing on production. Some relief is also expected from easing edible oil prices with the lifting of Indonesia’s export ban and import duty relief provided by Indian government," noted Crisil.
Private consumption remains a weak link
Slower wage growth coupled with high inflation is denting rural purchasing power. Not only has rural income growth slowed in nominal terms - from an average of 6.1% in fiscal 2021 to 4.1% in fiscal 2022, but real incomes have been declining, led by rising consumer price inflation, showed data analysed by Crisil. Also, the number of persons demanding work under the Mahatma Gandhi Rural Employment Guarantee Act (MGNREGA) remains high, showing distress in the countryside. In May 2022, for instance, around 31 million households demanded work under MGNREGA, which is almost 16% higher on-year and much higher than the corresponding pre-Covid period.

Moreover, higher food and fuel prices would shrink the budget for discretionary spending in the low- and mid-income categories since food and fuel form a greater part of their consumption basket. This is in sync with RBI’s consumer confidence survey which found that households “expected higher essential spending whereas the sentiments on non-essential spending remained downbeat.”
Also, there is the divergence in consumption. While recovery in low-priced items remains weak, high-ticket items are seeing a much better uptick (for e.g., see table below).

Terms of trade shock to widen Current Account Deficit (CAD)
Crisil expects the CAD to widen to 3% of GDP this fiscal, with imports becoming costlier owing to higher commodity prices, while exports face slowing external demand.
The Russia-Ukraine conflict and China’s slow easing of restrictions from its zero-Covid strategy has strained supply chains, further slowing merchandise trade and increasing logistic costs. Crude and petroleum products are India’s largest import items, accounting for 27% of total imports.

Rupee will continue to depreciate
Widening CAD, persistent risk-off sentiment owing to geopolitical tensions, strengthening dollar index, and continuous sell-off by foreign portfolio investors has put depreciating pressure on the rupee. The foreign portfolio investors have remained net sellers in Indian markets since October 2021. Since the start of calendar 2022, they net-sold more than $23 billion, higher than the net purchase of $21 billion in the two years of the pandemic. Net foreign direct investment (FDI) inflows were robust in the March-ending quarter, providing some cushion to the currency, but were still dwarfed by the FPI outflows. At the same time, the US dollar index has appreciated more than 4% in 2022 so far.
The rupee has slipped 4.6% so far this fiscal (as of June 29, 2022). "Though India is less vulnerable to external shocks now compared with 2013, the shocks this time are much bigger with the US Fed on an aggressive rate hike path amid escalating geopolitical tensions. We thus expect the rupee to be under pressure in the near term. The exchange rate had already touched new lows, at 79/$ as on June 29. However, the pressure may ease towards the end of the fiscal, as crude oil prices are expected to come down, and the Fed slows its rate hike spree. Hence, we expect the exchange rate to settle to 78/$ by March 2023, compared with 76.2/$ in March 2022, with a lot of volatility thrown in between now and then," noted Crisil