Reserve Bank of India Ignores Oil Price Drop; Maintains Interest Rate

IndusView, Tuesday 2 December 2014 (London): The Reserve Bank of India (RBI) left its benchmark rate unchanged at 8.00% Tuesday, failing to take advantage of the drop in international crude oil prices and the resulting deflationary effect on India’s biggest import item.

The India crude basket, computed by the petroleum planning and analysis cell, was $72.51 per barrel on November 27 compared with $90.50 per barrel on October 9. The Indian basket of crude oil is based on the weighted average of Middle East sour grades (Dubai and Oman) and the North Sea Brent sweet grade of London.

Despite the lower oil price, RBI Governor Raghuram Rajan said he was still awaiting more proof that inflation was under control.

“Lower oil prices keeps inflation low and could have served as a cue for the RBI to reduce interest rates and foster GDP growth,” said Bundeep Singh Rangar, Chairman of London-based consulting firm IndusView. “It increases prospects of the Narendra Modi government meeting its fiscal deficit target for 2014-2015. A lower RBI rate would have helped ensure it also meets its GDP growth target.“

India imports more than two-thirds of its oil requirements, which constitutes 37% of total imports. A one-dollar fall in the price of oil saves the country about $648 million. Every $10 a barrel fall in prices lowers retail inflation by 0.2 of a percentage point and wholesale inflation by half a point, experts estimate. Lower oil prices, therefore, have a three-fold effect spread across the economy.

Cheaper energy moderates inflation, which has already fallen from over 10% in early 2013 to 6.5%, bringing it within the central bank’s informal target range. This should lead to lower interest rates, boosting investment.

Cheaper oil also cuts India’s budget deficit, now representing 4.5% of GDP, by reducing fuel and fertilizer subsidies: along with food subsidies, the total is $41 billion in the year ending March 2015—14% of public spending and 2.5% of GDP.

The government controls the price of diesel and compensates sellers for their losses. But, for the first time in years, sellers are making a profit. As in China, cheaper oil should reduce the pain of cutting subsidies. Since Oct. this year, India has ended diesel price subsides and raised the price of natural gas.

Gross domestic product expanded 5.3% in the July-September quarter from a year earlier, as a manufacturing slump took the bounce out of Asia’s third-largest economy. Growth in the previous quarter was at 5.7%. 
Thanks to growth in services and stronger-than-expected farming after a bad monsoon, the reading was higher than predicted by economists polled by Reuters, who on average forecast growth of 5.1%. On a year-on-year basis, trade deficit increased by 28.1 per cent during Q2 FY 15 (Jul-Sep) as compared with a decline of 24.1% in Q1 of 2014-2015.

Prime Minister Modi is keen to promote India as an investment destination. Moves are afoot to schedule Prime Minister Narendra Modi’s first bilateral visit to the United Kingdom for an event on January 30, the death anniversary of Mahatma Gandhi. The trip will be his first bilateral visit to Europe. U.S. President Obama is also due to visit to India as Chief Guest of its Republic Day parade on Jan. 26.