Shobhit and his fixed income team at HDFC MF have penned this very thought-provoking note, which highlights a valuation anomaly that many experts seem to have missed. When oil was above $100, the rupee traded around 61 to a dollar. Now, when oil is below $50, how can the rupee be at 62 to a dollar? Read on as Shobhit takes us through a possible explanation for this valuation anomaly and what this might portend in the coming months.

In September14, when oil was $100 and INR 61, if a poll was conducted about the level of INR should oil fall to $50, an overwhelming majority would have suggested INR at 50-55 in our opinion.

12thJanuary15 : Oil is $50 but INR is 62. Is this a paradox or has something changed ?

On discussing this with economists & experts, one reason cited was the strength of US$.

The fallacy in the US$ strength argument

A $50 fall in oil prices equals a saving of 2.5% of GDP in CAD as against CAD of 1.9%, 1.1% and 1.3% (as % of GDP) in the previous three quarters of CY14 respectively. These savings are so real and so massive, that they have the potential to alter the USD/INR demand supply equation on a sustainable basis. In view of this, the indirect impact of strength of USD, if any, should be moderate and temporary in our opinion.

It is therefore surprising that the INR has actually depreciated by 4% v/s US$ in this period.

A possible explanation

The fall in oil price is not only a recent one but a sharp one too. Consequently, the quarterly average prices are falling with a lag. Further, India's oil imports enjoy nearly a six week credit period, which implies that the effective price for India on cash basis will fall sharply in Jan-Mar15 and Apr-Jun15 quarters.

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