Implications of Euro declining to be at par with dollar and higher oil price

Just a month back if someone had told that Euro would depreciate down all the way to be at par with dollar, very few people would have believed. But now that looks very likely to happen. As per the latest poll prediction for the upcoming snap elections in Greece, anti-austerity party Syriza is leading which means there is likelihood of it throwing out all anti austerity measures and also may ask for writing off of Greece debt by EU on coming to power. This would be catastrophic for EU and more for Euro. I would not be surprised if we see Euro depreciating rapidly to be at par with dollar. This would also lead to further depreciation of emerging market currencies and would result in increased imported inflation in these countries despite lower oil prices. I expect 2015 to be a bad year for emerging markets. The real challenge for all the central banks will be to manage currency volatility to keep imported inflation under check and also give a sense of stability required for economic growth.

We have seen since last decade that generally strong oil and commodities price lead to depreciation of dollar against other currencies and weak oil prices lead to dollar appreciation. The chart 1 below shows the direct correlation between crude oil price movement and exchange rate of dollar against Euro.

Chart 1: Crude oil price vs Euro-$ exchange rate
Source: ECB, Bloomberg, Niraj Shah Research

But imagine a scenario when I believe there is likelihood of strengthening of oil and other commodities price from current lows and yet dollar remaining relatively steady within a narrow range (or I would rather say that dollar would remain steady or not likely weaken in the same proportion as seen in the past) due to continuing economic and political turmoil in Euro zone and overall weak growth in emerging markets. It would be relatively new phenomenon and what can be the implications for emerging markets like India, Russia, China, Brazil, etc.

Chart 2: Crude oil price vs Rouble exchange rate against $
Source: ECB, Bloomberg, Niraj Shah Research

This would be good for Russia as higher oil price along with relatively strong dollar would translate into higher revenues. Just to give an example for Russia. Refer to chart 2 above and there is high correlation between crude oil and Rouble. Crude oil price has declined 40% in a year to current $58/bbl, while rouble has declined 75% to 60/$. So at current oil price, Russia is earning Rub 3,480/bbl. Now suppose oil price increase by 40% to 80$/bbl over next 1 year but rouble becomes stronger against dollar by say only about 20% to 48/$ at which Russia would earn Rub 3,840/bbl. So it would have an incremental earnings of about $ 220mn/day or $80bn in a year taking into account its average daily production of 10mbpd (million barrels per day) than it would have earned at low crude price keeping the production unchanged.

Chart 3: Crude oil price vs Rupee exchange rate against $
Source: ECB, Reserve bank of India, Niraj Shah Research

Even though India’s currency does not have much correlation with oil price movement as can be seen from the chart 3 above as correlation coefficient is only 0.4. Assuming oil price increases from $60/bbl to $80/bbl. This would increase India’s oil import bill by about $76mn/day or $27bn/year. But in Rupee terms, impact can be much higher in the likelihood scenario of dollar remaining strong and steady unlike in the past when increase in crude oil and other commodities prices led to weakening of dollar against major currencies.