Morgan Stanley Warns of Potential Economic Instability in India Due to Sustained Oil Prices

Morgan Stanley’s team has issued a warning regarding the potential impact of sustained oil prices at $110 per barrel on India’s economy. This situation could compel the Reserve Bank of India (RBI) to resume its cycle of interest rate hikes, as India, a leading global consumer of crude oil, is particularly vulnerable to fluctuations in oil prices.

The financial services firm warns that a $10 increase in oil prices could lead to a 50 basis point rise in inflation and a 30 basis point widening of the current account deficit. If oil prices exceed $110 per barrel, higher domestic fuel costs may drive inflation further, pushing the current account deficit beyond a manageable 2.5% of GDP and exerting depreciation pressures on the currency. Such dynamics would likely necessitate interest rate increases by the RBI.

Despite the RBI maintaining its policy rate unchanged on four occasions and adopting a hawkish posture in response to inflation surpassing its 4% target, it may need to reassess this strategy due to the inflationary pressures linked to oil price fluctuations. The central bank’s current projections assume an oil price of $85 per barrel for the latter half of the fiscal year ending in March 2024. However, ongoing surges in oil prices might compel the RBI to adopt a more cautious stance towards interest rate reductions in order to maintain macroeconomic stability.

In contrast to the RBI’s outlook, Morgan Stanley anticipates a more manageable average oil price of $95 per barrel, suggesting that India would be better equipped to handle prolonged prices at this level.

The report also noted a decline in foreign direct investment (FDI), which fell from $70 billion in the second quarter of 2021 to $33 billion in the same period this year. Nonetheless, India’s share of global FDI flows has risen, reaching 4.2% in the first quarter of this year.

Additionally, Morgan Stanley emphasized the risks associated with the upcoming elections, which could result in the formation of a weak coalition government. Such a government might prioritize redistributive policies over enhancing capital expenditure and enacting supply-side reforms, introducing further uncertainty into India’s economic outlook. This shift could exacerbate the economic challenges arising from oil price volatility, thereby complicating efforts to stabilize the economy.