Oil trade in rupee can be ‘game changer’ for India

NEW DELHI : India’s imports of Russian oil using rupees can set off a virtuous cycle of a stronger domestic currency and lower inflation, which can boost long-duration assets such as growth stocks and real estate, according to Charles Gave, Founder of global investment research firm Gavekal Research.

In a recent note titled ‘India And The New World Order’, Gave said the fundamentals influencing inflation, interest rates, exchange rates and economic activity in India are changing in a way that could prove “transformational” for the economy.

“India is now the world’s most populous nation and the largest democracy. This political setup has stopped its government following China’s development approach, which has relied on financial suppression, directing excess savings towards infrastructure and running an undervalued currency by tight management of foreign exchange movements and the capital account,” Gave said.

He pointed out that India has tended to be permanently on the cusp of a balance-of-payments crisis due to its reliance on energy imports priced in US dollars.

“As a result, the Reserve Bank of India’s overarching goal has been to prevent a balance-of-payments crisis,” he noted.

During boom times, India’s current account deficit has blown out past 2 percent of GDP, leading the RBI to raise rates in order to engineer a slowdown. Once the current account deficit has shrunk to a tolerable level, the central bank has lowered rates and the upswing has restarted.

“It has been a stop-start policy, with stops dictated by the current account,” he said.

Geopolitical Tailwinds

What has changed now is the global energy markets due to the war in Ukraine.With Russians not able to easily sell oil and gas to Europeans, they have found willing buyers in India.

“Transactions have started to take place in rupees, which, if continued, could be a game changer for India,” Gave said, adding that the country’s external financing constraint will be greatly reduced if it can buy more oil using Indian rupees.

“In addition, Indian citizens hold what may be the world’s biggest private sector inventory of gold and silver, which could be switched to productive assets if returns were attractive. In this case, we could see an epic shift from “scarcity” assets into “efficiency” assets,” he added.

Assuming that India runs an ex-oil current account deficit of $50 billion, its forex reserves of over $500 billion mean it is covered for the next decade.

“As a result, the RBI will be able to shift its dominant focus from avoiding a current account deficit to a new goal of reaching price stability denoted by an inflation rate of 0% to 2%. To achieve this end, it will need to keep short rates a little higher, and for a little longer, than generally expected,” Gave said.

Its tool for lowering both inflation and interest rates will be exchange rate management, with the RBI aiming for the rupee to become a “strong currency”.

This should lead to capital inflows and a stronger rupee, a “powerful combination” that tends to lower long-term rates in India. Thus, long-duration assets such as Indian growth stocks and real estate should boom, Gave said.