How do the oil prices affect the Rupee – Dollar exchange rate?

by Manshu on August 24, 2008

in Opinion

At the beginning of 2008 the Rupee rate went as high as 39 to a Dollar and at that time it didn’t look like it will be back to 43 so soon. Economists and Analysts were heralding this as a new era and were asking everyone to reconcile to the new realities of the market.

Just a few months down the line everything has changed. While there are many reasons that pushed the Rupee to 43 levels, perhaps the most unexpected was that oil prices went up to $143 a barrel.

India imports 70% of its oil needs and when the price of oil doubles, it makes a big dent on the country’s fiscal balances. The current account deficit has almost doubled from 2007 in terms of value, and has reached 1.5% of GDP, up from 1% of GDP last year.

Basically that means that to continue to fund India’s imports, the country needs to keep buying dollars and by doing that the value of the Dollar goes up while the value of the Rupee goes down.

High oil prices also mean that the oil companies need to buy Dollars in order to get hold of the expensive oil and further push down the Rupee value. In absolute terms every 10 dollar increase in the price of an oil barrel increases the current account deficit by roughly $6.5 billion dollars and this has to be funded by more dollars.

The RBI has sufficient dollar reserves to ease the pressure off the rupee decline, but the high levels of inflation do not allow it to buy off dollars in the open market as freely as it used to do earlier.

All these factors play out together and push the rupee value down, which is good for exporters but not so good for oil prices and the trade deficit.

Manshu Verma

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