Oil price hike impact: Inflation to average around 5.5%; BoP deficit may hit $40-70 billion

The Russia-Ukraine war has impacted commodity prices across the globe. As Brent continues to trade above USD 110 per barrel, inflation, growth worries abound.

To allay some of the worries and to get a better sense of where the economy is headed, CNBC-TV18 spoke to Indranil Sengupta, Head-Research & Economist at CLSA, India, and Upasna Bhardwaj, Senior Economist at Kotak Mahindra Bank.

Sengupta shed light on the possibility of war risks being overdone. He thinks inflation will average around 5.5 percent with the oil price hike. He reckons that the Reserve Bank of India has around USD 80 billion of excess reserves and hence doesn’t see any problem on the external side. He expects the RBI to hike rates by 100 basis points (bps) in FY23.

He said, "We expect the increase in oil prices to be met by price hikes as well as oil tax cuts. So, we think that inflation will average around 5.50 percent with a pump price hike of around USD 15 to the barrel. Recall that pump prices are currently linked to USD 85 per barrel, which is pretty much around the inflation average of this year. We do expect the RBI to hike 100 basis points in FY23. But we do not see the inflation situation getting out of hand."

Concurring with Sengupta, Bhardwaj also reiterated that there is adequate forex buffer for the situation at hand. She said that there is a possibility of India seeing a USD 40-70 billion deficit in Balance of Payments (BoP). She remains confident that there will be no financial instability, though there might be risk for macros.

She said, "On the foreign exchange reserves side, there is adequate buffer, which definitely provides us hope in this kind of a crisis situation because otherwise, there is clearly going to be significant outflows on the capital front side going ahead if this kind of a risk process and that is where the balance of payment turns deficit quite hugely. We don't know exactly where this will settle and it could be anywhere in the range of $40 billion to a $70 billion deficit, the balance of payments. So clearly, RBI will have to come and they have the wherewithal at this point in time."

She added, "Clearly the risk on the macros - the fundamentals will be there. But on the other side, there are adequate buffers by the RBI to ensure that there is no financial instability."

On growth, she said that oil at USD 100 per barrel will impact the real GDP growth. She estimates a 50-bps reduction in GDP growth if oil hits USD 100 per barrel mark.

"That $20 itself is causing about a 50 basis reduction in GDP expectation. So earlier, we were looking at FY23 expectations at 8.1 percent, if crude oil prices were to average at $100 that is assuming the second half of the year does see a correction in oil prices, then we are looking at 7.6 percent. Otherwise, our worst case scenario could be even towards 7 percent if crude oil prices remain where they are today," she said.

On supply side pressures, Bhardwaj mentioned that even if the war subsides, it will take months for the supply to stabilise. She added that the situation may worsen if commodity prices rise beyond a month.

"Even if the war situation was to subside, the supply-demand imbalances that are there will still take a few months to stabilise. So I think it clearly has an adverse impact on growth. That is why for now, we will have to wait and watch because much of it is speculation. So let us see how far this really goes and that is why we were building in scenarios as of now. Clearly, it will not be a linear function. So it may actually incrementally start worsening the situation if we see much higher crude oil prices or much higher commodity prices settling in," she said.

Watch the video for the full interview.