Global rating agency Moody’s on Wednesday said that higher oil prices and interest rates will put pressure on India’s twin deficit – fiscal and current. However, the good news is that the gross domestic product (GDP) growth remains robust.
Fiscal deficit means expenditure higher than income, while current account deficit (CAD) implies shrinking value of a country’s net foreign assets, which means less earnings and more payments in foreign currency. These two deficits are expressed as a percentage of GDP.
The government fixes a target for fiscal deficit and prepare the Budget accordingly, while CAD is not entirely in the hands of the government or monetary authority and it depends upon geo-political situation and the prices of crude oil. Finance Minister Arun Jaitley, while announcing the Budget on February 1, had set the target for fiscal deficit at 3.3 per cent for the current fiscal.
Moody’s said that higher oil prices add to short-term fiscal pressures, following the reduction in the goods and services tax on some items and relatively high increase in the minimum support prices for some crops. “We see risks that the deficit will be wider than budgeted. However, temporary fiscal slippage, if any, will not offset robust nominal GDP growth and large domestic financing base that will keep the government's debt burden broadly stable,” the agency said in its report.
India buys three fourth of its crude from abroad. The product basket is mixed of sources which is why prices here are always expressed as that of the Indian basket of crude oil. This basket represents a derived mechanism comprising sour grade (Oman & Dubai average) and sweet grade (Brent dated). Currently the price of this basket is around $71-72 a dollar which is higher than the so called comfort level of $68-70 a barrel.
The agency noted that India's deregulation of both diesel and petrol prices have reduced the fiscal impact of rising oil prices. However, liquefied petroleum gas (LPG) and kerosene remain regulated and subject to subsidies, which were budgeted at 0.5 per cent of the government expenditure for the year ending March 2019.
The agency said that oil prices at current levels will raise the expenditure and add to the existing pressure on the fiscal position. Although the government may cut back on capital expenditure to limit the fiscal slippage, as has happened in the previous years, such cuts may not fully offset the revenue losses and higher spending on energy subsidies and crops' price support.
Current account deficit
The agency mentioned that this deficit will widen, but will not jeopardise India's strengthened external position. Higher oil prices will also contribute to a wider current account deficit. However, the current account gap will remain significantly narrower than five years ago. Moreover, economy-wide external debt is limited and the country's foreign exchange reserve buffers are ample.
“Overall, we continue to assess India's external vulnerability risk as low. We expect the current account deficit to widen to 2.5 per cent of GDP in the fiscal year ending March 2019, from 1.5 per cent in fiscal 2018, driven by higher oil prices and robust non-oil import demand,” it said. This estimate is slightly lower than SBI’s estimate of 2.8 per cent of GDP.
Interest rate
Followed by two successive policy rate hikes by the Monetary Policy Committee, the agency said that rising interest rates has hurt banks profitability. Higher interest rates, particularly a spike in yields on Indian government bonds, has led to a significant mark-to-market investment losses for banks over the past few quarters due to their substantial holdings of government securities. As of August 27, the benchmark 10-year government bond yield stood at 7.9 per cent from 6.7 per cent on September 1 last year.
The agency estimated the provisions for investment losses to wipe out around 16 per cent of banks' operating profit in the fiscal year ending March 2019. Moreover, “higher borrowing costs coupled with rising input prices linked to higher oil prices could weaken the asset quality for corporate and SME loans. Higher rates will add to tighter financing conditions, particularly for SMEs’’.