Bank of America Merrill Lynch widens CAD estimate due to oil prices

Expecting oil prices to slide further, Bank of America Merrill Lynch (BofAML) Monday widened its current account deficit (CAD) estimate by 0.20 percent to 2.8 percent of GDP for the fiscal year 2018-19.

The widening current account gap is one of the major concerns which is putting pressure on the rupee, which has depreciated 13 percent against the dollar this year. Brent breached the USD 80 per barrel mark Monday and analysts at the American brokerage said they expect it to go up further to USD 95 by June 2019, which will put pressure on the current account.

"We raise CAD forecasts by 0.20 percent to 2.8 percent of GDP in FY19 and by 0.10 percent to 2.9 percent in FY20 with our oil strategists hiking Brent forecasts," it said.

The country's CAD widened to USD 15.8 billion or 2.4 percent of the GDP for the first quarter. The brokerage added that a foreign currency swap window for oil marketing companies (OMCs), the largest consumer for dollars, is also unlikely to help and voted in favor of tapping into the diaspora by doing an NRI bond issue.

"We do not think it is possible for the RBI to set up a forex swap window to fund oil imports by OMCs with our oil strategists seeing USD 95 per barrel by June 2019," it said. The NRI bonds option has been successfully utilized thrice in past instances of rupee depreciation.

Adverse trade seasonality and the scheduled general elections are other challenges for the country's external sector, according to the brokerage. It said it is "scarcely possible" for the RBI to pre-commit to swap USD 8 billion a month when USD 25-30 billion of forex intervention would push down forex reserves to the eight-month import cover, on the FY20 basis, that it sees as "critical" for rupee stability.

If foreign portfolio flows do not revive and the US-China trade war escalates, the brokerage feels the RBI will have to sell another USD 10-15 billion by March itself to fund FY19 CAD forecast of 2.8 percent of GDP.

Upping the foreign currency inflow through NRI bonds is also a better option than hiking rates, it said. In order to stem the rupee depreciation, the brokerage said the government and the apex bank can potentially take measures like hiking rates at the next policy review, operational measures like curtailing net open positions and rebooking of canceled forwards or hiking the cost of trade finance and also tariff hikes.