Oil Companies to Raise Rupee

Brian Hicks

Written By Brian Hicks

Posted August 30, 2013

When it comes to developing economies in Asia, we often have very high expectations of the stamina of their economic growth. But the fact is, developing countries like China and India are struggling in the same way as many post-industrial nations.

Traders and economists have been disappointed in China’s lackluster growth, and India’s rupee has not been faring well on international markets.

mar 2011 oil pumpIndia’s rupee has been one of the worst performing currencies in 2013. The currency fell 19 percent this year, and the Indian economy has struggled with slow growth.

There are a variety of reasons for India’s waning currency, and they are both international and domestic. But a large reason why the rupee has been declining is because of the dollar.

As the dollar appreciated and the world economy tanked, investors around the world converted their currencies into dollars – causing high demand and forcing countries like India to pay more rupees for the dollar.

On a domestic level, there has been slow growth in the economy and a high account deficit, which has contributed to the rupee’s downfall.

But the Indian government may have a remedy to this plan.

The Reserve Bank of India will sell U.S. dollars to three key state-run oil companies in India: Indian Oil (NSE: IOC), Hindustan Petroleum (NSE: HINDPETRO) and Bharat Petroleum (NSE: BPCL).

This would take dollar demand from the exchange market, since India is required to have dollars to settle futures contracts.

Oil companies account for 40% of dollar demand in India.

As a result of lowering dollar demand, this would give an upper hand to the rupee – or so the theory goes.

Will it Work?

The plan looks promising and has a strong chance of working considering the high dollar demand from oil companies. But other measures need to be taken in order to boost the rupee. Other options are being considered, such as scaling back on domestic fuel consumption to reduce energy imports and monetizing gold to reduce mounting precious metal imports.

India plans to further tackle oil by possibly raising state subsidies as an alternative way of decreasing import demand.

But what is most problematic is that despite the Indian government’s liberalization of foreign investment policy, many venture capitalists have not taken the bait.

After the new reforms were passed last year, many international companies and investors are leery of the new proposals and are waiting for more information before pouring funds into India.

Another reason investors may be nervous is because of the current state of the country’s account deficit, which amounts to $88 billion. We often hear of India’s rising middle class and growing wealth, but India still imports more than it exports.

And the country is still overly reliant on foreign currency, which only renders the rupee more vulnerable.

But I think the recent move to sell U.S. dollars to companies will be a good one, since the Indian economy is too dependent on other currencies like the dollar.

This, in turn, will help Indian oil companies whose credit ratings have suffered as a result of a weak rupee and sharing higher cost portions for fuel subsidies. But other problems will need to be worked out, such as subsidy delays from the government – causing oil companies to pay upfront in cash for imports and forcing these state-run entities to take out loans with higher interest rates. This adds to long-term debt and further weakens the credit ratings of these companies. But it can be offset with the help of the central bank, and a stronger rupee will mean a better credit rating for these companies on an international level.

A stronger rupee will also lower production costs for companies.

India’s central bank may have lost out on dollar reserves by selling to oil companies, but it can easily recoup those funds from oil futures when the rupee rebounds.

Another way to strengthen the rupee would be to raise prices, but with an upcoming election, this is unlikely to happen.

There was also a proposal in the Indian Parliament to grant $19.8 billion to subsidize grains for the poor. Another proposal will be voted upon next week that will give aid to farmers for construction and industrial projects.

These spending moves will not likely win investors over, and if the rupee is to be strengthen, spending must be lowered.

There are also outside factors to consider, such as the current Syrian conflict and the general skittishness of investors from conflict in the Middle East. And there is possibility of the scaling back of Federal Reserve stimulus spending. All of these factors are playing a role in India’s rising oil prices, which have risen by six percent since June.

Most importantly, India needs to do everything possible to create a more conducive atmosphere to win over investors like you.

Is India Worth the Buy?

India looks promising, but I would hold off until officials can get their economic affairs in order. Even high-ranking officials like Indian Prime Minister Manmohan Singh concede that massive change needs to take place for things to improve, but I don’t see it happening anytime soon.

For now, I would stick with domestic shale oil in the U.S.

And despite what’s going on overseas with Syria and the rise in oil prices, shale stocks are still a profitable bet. Smaller companies hold much of the shale drilling activity, and big companies are at least trying to catch up.

North Dakota is on its way to one million barrels a day in production, and things are going strong in Texas, especially in the Permian Basin and the Cline Shale, which will prove to be a good haven for future investment. There are new shale ventures with tremendous potential like the Manco Shale and the Piceance Basin out in Colorado.

But if you’re still interested in India, then wait with the other investors to see how India fares with its new policy measures.

For now, at least, park your investment dollars domestically. At a time of such uncertainty in the world, this is the safest play to keep you in the energy game.


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