"Why India is poised to be a major winner in the geopolitical crisis: The impact of buying oil in rupees and its effect on the economy"

2023-04-24 09:33:45

As everyone knows, India is now the most populous country in the world and by far the largest democracy.

In this week’s paper, I will try to explain why India is likely to be one of the very big winners of the geopolitical crisis that has shaken the world since the start of 2022.

Let me explain.

India has always suffered from a glaring lack of raw materials in general, and of energy in particular.

Having to import most of its energy, India found itself almost constantly with a deficit in its current accounts. And the more the economy, driven by a strong increase in population and gigantic needs for investment in infrastructure, grew, the stronger the internal demand was, and the more the demand for energy payable in dollars increased, which in the long term created the risk of a balance of payments crisis.

At that time, the central bank was pushing up short rates, to keep the rupee from crashing, and this rate hike had the usual effect of creating a recession, which lowered imports and lowered demand for oil. ‘energy.

And so, came talways a time when deficits were becoming so large that growth had to be slowed by raising rates at the risk of creating a recession.

It is this cycle that my first graph shows

We can clearly see that when the price of oil rises (the black line goes down), the current accounts deteriorate (the red line goes down).

And when current accounts fall below 2%, a rise in short rates becomes inevitable, recession arrives (grey hatching) to “restore foreign trade”

This is what my second graph shows.

And so the Indian economy has suffered for years from a rather ugly case of “stop and go”: as soon as growth accelerated, the central bank intervened to announce the end of the game and these jolts greatly hampered structural investments. needed in the country.

Where are we today ?

Current accounts are in deficit by nearly 4% in relation to GDP, short rates have already doubled, a recession is undoubtedly looming over us….

And yet, I don’t believe that rates will continue to rise, nor do I believe that the Indian economy will go into recession.

In fact, short-term interest rates will undoubtedly fall with inflation while the economy risks experiencing a real boom, which will not be inflationary.

For what ?

Quite simply because India now buys its oil in rupees and no longer in dollars and the seller is no longer Saudi Arabia but Russia, which changes everything for the subcontinent.

As Russia can no longer sell its oil to Europeans, it has chosen to sell it to whoever wanted to buy it, in particular India, and this oil cannot be denominated in dollars (Russia no longer has access to the dollar), nor in rubles (there are no rubles outside of Russia since Russia has had a very large surplus on its foreign trade for a long time).

Technically, this means that Russia cannot sell its gas and oil. what in the currency of the buyer country.

This will have the same effect on Indian foreign trade as if India had just discovered oil and gas reserves on its territory.

The constraint of foreign trade disappears.

Russia will therefore find itself with dumploads of rupees, with which it will be forced to buy either Indian government bonds or private sector assets in India.

In simple terms this means that Russia’s foreign exchange reserves will automatically be replenished in the currencies of the countries that will buy its oil and gas is that Russia’s foreign exchange reserves will no longer be kept at the Fed or the ECB, but in the central banks of the countries that purchase Russian products, which will lead to a gigantic development of the bond markets of these countries.

Note in passing that these payments will no longer go through the Swift system, but through state-to-state payments, which means that no one will have any more information on what is sold or bought in the world.

The international trade statistics will therefore become highly dubious, which will not facilitate my job.

At this point in the reasoning, it is curious to note that the embargo on Russia demanded by the USA had consequences.

First, to put an end to the payment monopoly that the dollar had on oil
And then to allow the development of local bond markets which will be formidable competitors for the American and European markets, especially at a time when these markets are of no interest.

This is called shooting yourself not in the foot, but in the head.

As far as India is concerned, this means, and I repeat that it no longer has any foreign trade constraints since a large part of its external deficits came from its energy purchases.

And these energy purchases will no longer be made in dollars, but in rupees

And that leaves India in an incredibly favorable position

The Indian Central Bank has indeed approximately 500 billion dollars of foreign exchange reserves (in US dollar, Euro, Yuan, Yen etc…) and approximately 50 billion dollars in gold. As the country is in balance or in excess in its international trade in energy, and as capital inflows are going to be substantial to benefit from the impending Indian boom, I have no doubt for a second that the Indian central bank is going to change its shoulder gun and stop managing the country according to the constraint of foreign trade to manage it in such a way as to lower the local inflation rate structurally and with it the long-term interest rates, which are at 7.5%.

The tool for doing this will be the exchange rate.

This exchange rate, which will structurally tend to rise, will be used by the central bank to slow down the economy when necessary. ‘

Interest rates will follow, falling, and equity markets, rising, with local consumption, local price increases being controlled by the exchange rate.

We risk having in India.