India looks for oil futures contracts

India’s government is planning to ask state oil firms to lock in their crude futures purchase prices.

New Delhi is anticipating a spike when U.S. sanctions on Iran snap back again in November.

Background

India’s economy can be described as a developing economy. It is the world's seventh-largest economy by nominal Gross Domestic Product. It is also the third largest economy in terms of Purchasing Power Parity (PPP). However, it ranks at 141 in per capita GDP (nominal). The Indian Rupee (INR) is the official currency of India which is a fiat currency and partially convertible.  A country’s currency is linked to their economy and the policies that govern the economy.

Over the years the value of any currency has depended on factors like inflation, employment, interest rate, growth rate, trade deficit, foreign investment and several macroeconomic policies. As a governing body, the RBI would manage the value of the rupee by controlling the supply - which would either make it cheap or expensive.

Read more about our analysis on the fall in the value of the Rupee here and here.

Analysis

India’s government is planning to ask state oil firms to lock in their crude futures purchase prices. The move would be another step to tackle a slide in the rupee, as oil prices are putting pressure on India, which imports some 80% of its crude demand. Its currency has fallen sharply this year against the U.S. dollar, amid a wider sell-off in emerging markets. “The futures should be locked in when crude price is down,” said the source, who is familiar with deliberations on the matter, adding the step should have been taken earlier.

The rupee, Asia’s worst performing currency this year, has depreciated about 12% year-to-date against the U.S. dollar, closing at 72.39 on Wednesday, after a record low of 72.99 on Tuesday. Markets were closed on Thursday. The government is expected to announce a set of measures to discourage non-essential imports to stem the slump in the currency.    

Separately, a senior finance ministry official said there was a view that the rupee could weaken further in the next two months if proposed steps failed to kill “speculation in the rupee market”. “The gap between the announcement of steps and action is creating a space for speculation. We have to stop this,” said the official.

Officials at oil companies said they were open to the idea of locking in futures if the government asked. A senior official at Indian Oil Corp, a state-owned oil marketing company, said they were considering some options in terms of forwarding contracts. He declined to give details saying this was “market sensitive information”.

An official at BPCL, another state-owned oil firm, said they were trying to hedge margins, under a policy reviewed every quarter. BPCL is also studying a proposal to buy dollars directly from the Reserve Bank of India instead of the market, in a bid to quell strong dollar demand that is denting the rupee.

India’s risk-averse state-owned refiners have in the past been reluctant to engage in futures trading or hedging strategies, fearing administrative blow-back if bets go wrong. The refiners typically buy up to 70%  of their oil needs through term deals and the remainder through spot markets.

Counterpoint

Due to a high volume of foreign investors in the Indian capital markets, it is highly unlikely the slide in the value of the rupee will halt anytime soon. The US-China trade war, as well as the sanctions on Iran, are putting immense pressure on emerging markets such as India, as the foreign investors are slowly withdrawing their funds.

The oil futures contracts will arrest the fall in the value of the currency only on a temporary basis. Once the contracts have a higher returning interest rate, it will start to lose public confidence which will result in another dramatic fall in value.

Assessment

Our assessment is that the rupee will continue to underperform until oil prices stabilise in the short term. We feel that the RBI will continue to sell its Dollar reserves in a staggered approach in order to avoid a shock to the rupee. We believe that India’s monetary and fiscal policymakers need to consider stabilising internal currency flows as a short-term fix