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Like clockwork, the surge and resurgence of crude oil prices begin to manifest in trade deficits, weak exchange rates and bearish sentiment in Asian economies. With crude oil now closer to the $100 per barrel mark, analysts are redrawing their assumptions on balance of payments, fiscal budgets, and exchange rates of these economies.
Nomura analysts believe that India, Indonesia, and Thailand will see a bigger impact than the rest of the Asian economies from a global oil price rise. Every 10 percent increase in oil prices translates into a rise of 0.2 percent of GDP in fiscal costs to these countries, they have calculated. A 10 percent oil price increase also adds 0.2 percentage point to retail inflation, worsens the current account deficit (CAD) by 0.3 percentage point and drags GDP growth down by 0.1 percentage point.
These may not look big, but together spell trouble for the Indian economy and by extension the rich valuations of its stock market. No wonder, investors are thinking about putting the old strategy of ditching Asia and opting for US markets instead. The fact that Jay Powell, chair of US Federal Reserve, told markets in no uncertain terms that higher interest rates will hold for longer, makes investors want to abandon the Asian ship and scurry back to safer US shores.
But India has got something that other Asian economies don’t have. No, it is not demographic dividend or any of the other fancy long-term potential metrics that analysts brandish. It is the promise that the inclusion of its bonds in JP Morgan’s emerging market bond index will bring lazy dollars into the local markets. It is not a small amount at close to $50 billion.
While we may argue that the actual flow is due post June 2024, bond markets are all about hedging today for future risks. That means savvy bond investors would buy Indian government bonds today to sell later to these passive fund managers when they finally come. Ergo, a chunk of the $50 billion expected may start trickling in from the next couple of months. As our Chart of the Day details, this will take care of the impact on the CAD from oil price increases.
Financing the CAD isn’t going to be a cakewalk since foreign direct investment is looking uncertain, but it is going to be easy enough to get, never mind the quality of dollars that are coming in. Note that the bond inflows expected are based on allocations and do not necessarily respond to US interest rate differentials or even market uncertainties. This is as good as guaranteed money.
The hole in the external balance sheet won’t be as big as feared, though. Even with an expected surge in the oil import bill and increase in other imports, and deceleration in exports, the CAD is likely to be lower as a percentage of GDP this year versus last year. Nomura and Kotak Institutional Equities forecast estimates CAD to be 1.5 percent of GDP in FY24. That is better than the 2 percent of GDP last year.
While external balance sheets may bear some of the brunt and exchange rates may also face pressure, the fiscal impact of oil prices may not be much this time. For India, retail fuel prices are market determined, but pump prices haven’t changed much since 2022. Any hike in retail fuel prices would drive the government to give tax relief to the people as scheduled national polls next year make it imperative to offset any negative event over the public. Elsewhere in Asia though, the fiscal impact is seen as negligible.
An oil price surge is always the fly in Asia ointment. This time, though, Asia may just be able avoid the unpleasantness. Investing insights from our research team
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