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The year 2018 has so far not been very good for the Indian rupee. After a robust rally over 6 per cent against the US dollar in 2017, the rupee has been knocked down hard against the greenback. While the recovery in the US dollar index and foreign-money outflows are among the major factors that have been driving the rupee lower, there is a third factor too — crude oil prices rising to multi-year highs.
The West Texas Intermediate (WTI) Crude Oil prices have surged above $70 per barrel for the first time since November 2014. Though the oil prices have been on the rise since mid-2017, the inverse correlation of the rupee’s fall with the oil price rise has been strengthening ever since WTI prices crossed $60 per dollar this year. The same has been visible on the domestic front as well, with the crude-oil futures contract traded on the Multi Commodity Exchange (MCX). So assuming that this inverse correlation continues, we try to project where the rupee is headed based on the forecast for the WTI and MCX crude-oil prices.
Oil outlook
The WTI crude oil ($71 per barrel) broke a crucial resistance level of $65 in April. The region between $65 and $64 will now serve as a strong support. Next crucial support is at $62.
A rally to $75 or $76 is likely in the short term. Though a pull-back from there to $67 or $65 cannot be ruled out, it is likely to be short-lived.
An eventual break above $76 will pave way for the next target of $80.
A complex inverse head-and-shoulder pattern (a bullish reversal pattern) formed between 2015 and 2017 gives a target of $85 for WTI crude. A rally to $85 will also keep the possibility alive of the oil prices revisiting $100 levels in the coming years. A similar inverted head-and-shoulder pattern on the MCX-Crude Oil (₹4,750 per barrel) contract leaves the target of ₹5,700 on the domestic front. An intermediate pull-back to ₹4,400 or ₹4,300 within this rally cannot be ruled out. A strong support in the ₹4,400-4,300 region is likely to limit the downside in MCX contract.
Rupee forecast
From the forecast for the WTI and MCX contracts, the approximate value of the rupee has been derived (by dividing WTI by MCX prices) as shown in the table below.
The calculation gives a wide range of 68.75 to 73 for the rupee. With majority of the values falling between 70 and 72, the probability of the rupee weakening towards this range is high as the oil prices surge to $78-80 levels.
The other supporting factor needed for the rupee to retain its weakness is dollar strength. The dollar index has been gaining strength on the back of rising US Treasury yields. The long-term outlook for both the yields and the dollar index remains bullish.
The 10-year US Treasury yield can rise to 3.25 per cent in the short term. An intermediate pull-back from 3.25 per cent cannot be ruled out. But the yields are likely to remain above 2.70 per cent.
An eventual break above 3.25 per cent will see the 10-year Treasury yields surging to 4 per cent over the medium- to long-term. However, the dollar index is likely to stay above 90.70 and can test the levels of 95 and 96 in the short term. A strong break above 96 will see the index revisiting 100 levels.
But will strong dollar pull the oil prices down? Not likely, because the inverse correlation between the dollar and oil prices is being broken since the beginning of this year.
Impact on macros
Crude-oil prices rallying to $78-80 or even higher will see the country’s import bill surging sharply.
On an average, oil constitutes about 25 per cent of India’s total imports. The surging oil prices have seen the import bill increasing by 25 per cent in FY-20118 to $109 billion from $87 billion in the previous fiscal. This, in turn, has pushed the trade deficit of $156.8 billion in FY2018, the highest over the past five years.
The current account deficit (CAD) will widen further because of the increase in trade deficit. As on December 2017, the CAD for FY2018 at $35.68 billion has more than doubled from a deficit of $15.12 billion in the entire FY2017.
The deficit concern is likely to keep the rupee under pressure, and cap the strength in the currency, going forward.
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