India's rupee dilemma

After falling consistently against the US dollar for most of this year, the Indian rupee has managed to gain some ground over the last few weeks. It has gained almost 5 percent from its lowest levels reached in October. The fortunes of the rupee, which even after the recent appreciation is down about 11 percent since the beginning of the year, have been tightly linked to the price of crude oil in the global markets. This is no surprise since imported oil meets about 80 percent of India's total demand. The value of the rupee tanked amid the uptrend in oil prices this year which lasted till early October. Since then, the rupee has gained against the dollar in tandem with the fall in global crude prices. Brent Crude has dropped by a massive 30 percent since early October, when a barrel cost around $86, to around $60 today. This sharp fall has been the result of a dramatic change in mood in the oil market. Investors until a few weeks ago were worried about the lack of sufficient supply in the market due to disruptions in arrivals from major producers such as Iran and Venezuela. Now, however, the markets are worried about possible oversupply as the U.S. has softened its stance against Iran and turned into the largest crude oil producer in the world with the boom in shale production. Worries about a drop in global demand due to faltering growth in major economies like China may have also contributed to the fall in prices.

The fall in global crude oil prices comes as a big relief to the Central government, which has faced increasing macroeconomic and political pressure due to rising prices. According to UBS, a drop of $10 in the price of oil can improve India's current account and fiscal deficits by 0.5 percent and 0.1 percent of GDP, respectively. The ruling party may be pleased with falling oil prices in the run-up to the general elections next year. Fuel prices across major Indian cities have fallen significantly in the last few weeks. The Reserve Bank of India will be relieved as it will have to worry less about the rupee and oil-induced inflation. Foreign investors, who have been net sellers this year, have turned net buyers this month. This points to an increase in investor confidence in the economy as the fundamentals improve. But amid rising global uncertainties, it may not be so easy to map what lies ahead for global crude oil prices and the rupee. The December 6 meeting of the Organisation of the Petroleum Exporting Countries will make clear the response of oil producers to the sharp fall in prices. Shale companies are also likely to respond to falling prices by cutting production; the profit break-even point for shale producers, however, is anyone's guess. India should capitalise on the relief offered by the fall in oil prices to improve its preparedness for any future jump in oil prices.