India Strategy; QE2 = higher crude = higher CAD :: RBS

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India Strategy
QE2 = higher crude = higher CAD
QE2 (quantitative easing) is widely expected to lead to higher inflows to emerging
markets, including India, but resulting higher crude prices could lead to a higher
current account deficit. We estimate that a US$10/bbl increase in crude oil price
will add US$9bn to the annual import bill and 50bp to current account deficit.




Significant dependence on crude oil imports is a risk factor for current account
India imports roughly 75% of its domestic crude oil requirement. Thus, potentially higher
crude oil prices as a result of quantitative easing would increase India’s trade and current
account deficit.

We estimate a US$10/bbl crude oil price hike would add US$9bn to annual import bill
Such an increase would imply a 0.5% hike in the trade and current account deficit as a
percentage of GDP. As such, although QE2 could lead to higher portfolio inflows to India, it
could also lead to a higher current account deficit. The RBS economics team currently
forecasts a current account deficit of 3.8% of GDP for FY11 assuming an average crude oil
price of US$75-80/bbl.

Higher international oil prices also increase the under-recovery for OMCs
The oil marketing companies (BPCL, HPCL and IOC) would see higher under-recoveries
(and hence subsidy burdens) in the event of higher oil prices. According to Avadhoot Sabnis,
our energy analyst, a US$1 crude oil price hike would increase the industry’s annual underrecovery
by Rs32.6bn. RBS has Sell ratings on BPCL and HPCL and a Hold rating on IOC.
For further details, refer to our 8 October 2010 publication, OMCs: Challenges to overcome.


We maintain our cautious view on Indian equities
We remain cautious on Indian equities in view of rich valuations (our estimated 12-month
forward P/E of 18.5x, a 40% premium to Asia ex Japan), persistent inflation and the potential
for a wider current account deficit. That said, the earnings disappointment we expect for FY11
and FY12 did not materialise in the September quarter, especially for banks.