Declining crude prices adds elbow room for rate cuts amidst weakening rupee

India’s central bank may have sufficient elbow room on monetary easing should the need arise in the future, as a faster pace of decline in global crude oil prices than the rupee’s retreat against the US dollar limits potential downside risks of imported inflation.

“Despite a weaker currency, the falling price of Brent crude oil is taking the bite out of imported inflation, except for specific items such as airline fuel,” said Rahul Bajoria, Head of India and ASEAN economic research, BofA Securities. “The pressure on the rupee is a slow but steady source of a second-round effect on inflation, and adds to some upside risks to our assumptions.”

The rupee has already weakened by close to 1.5 percent against the US dollar since early January, but Brent crude prices have fallen 7 percent in the same time period, potentially cushioning the impact of the rupee’s retreat on the import bill.

Studies by the Reserve Bank of India (RBI) showed that almost 40% of the consumer price index (CPI) basket is influenced by external factors, and for every 1% depreciation in the exchange rate, 7 basis points (one basis 0.01 percent) of pass-through are visible over two or three months.

“As per the RBI’s sensitivity analysis, a 5% depreciation in the INR adds 35bps to headline inflation. This will be countered by softness in global commodity prices,” said Gaura Sengupta, chief economist, IDFC First Bank. “Given the low share of imported goods in the CPI basket, the risk from imported inflation remains low.”

IDFC First Bank does not expect retail petrol and diesel prices to change as oil marketing companies have made losses on LPG. “So to compensate them, retail petrol and diesel prices will remain unchanged,” said Sengupta.India’s January CPI inflation print – at 4.3 % – was published after the February 7 monetary policy review reduced the benchmark policy rate for the first time in nearly five years. The repo rate, or the rate at which funds are loaned by the central bank to high-street lenders, was reduced 25 bps to 6.25%.

However, some economists have expressed concerns over the spillover impact of a weak rupee on 40% of the CPI basket, given the pronounced say of the external factors on this category of goods.

But easing energy prices could come as a relief as crude constitutes the country’s biggest import expenditure, in turn helping ease consumer prices and creating room for further rate reduction by the monetary policy experts.