Russia-Ukraine War: What it portends for India

The situation in Ukraine is now one of war, with Russia formally invading the territory even as the world has expressed umbrage and topped it up with some sanctions.

Madan SabnavisUpdated: Friday, February 25, 2022, 09:12 AM IST
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Police block Red Square ahead of a planned unsanctioned protest against Russias invasion of Ukraine in central Moscow on February 24, 2022. - Russian President Vladimir Putin launched a full-scale invasion of Ukraine on Thursday, killing dozens and triggering warnings from Western leaders of unprecedented sanctions. Russian air strikes hit military installations across the country and ground forces moved in from the north, south and east, forcing many Ukrainians flee their homes to the sounds of bombing. | (Photo by Alexander NEMENOV / AFP)

The situation in Ukraine is now one of war, with Russia formally invading the territory even as the world has expressed umbrage and topped it up with some sanctions. This is a big blow for the world, as it is probably the first time that we are witnessing such an attack which is quite unprovoked. Russia is a major oil and gas player in the global economy. This means that any disruption in terms of a war or deeper sanctions that keep Russia in check have the potential to disrupt the global economy, which just appeared to be on the recovery path after the Omicron scare.

What does all this mean for us in India? The first impact has been seen in the volatile stock indices. This of course is part of the show, as markets swing either way based on all the information that is available. Such volatility will continue to pervade for some more time. Second, crude oil price has crossed the $100/ barrel mark. This was expected even earlier, but analysts are talking of $120/ barrel. This will be a concern, given that our oil import bill comes close to $150bn a year and hence, any increase in price will affect our trade deficit.

While consumption did fall during the pandemic in 2020, it has been back to normal and with pent-up travel demand increasing along with the proclivity to use one’s vehicle and eschew public transport, there has been an increase in the consumption of oil products. Hence even a 10 per cent increase in price on a permanent basis will increase our annual import bill by at least $10-15bn (there will be some balancing by higher exports of refinery products).

Therefore a higher current account deficit seems to be on the cards for sure. Third, higher oil prices also mean that there will be pressure on the rupee and this is where the markets are getting jittery. The rupee had been strengthening of late but this will get reversed and there is potential for depreciation now, depending on how soon the oil prices climb. This, in turn, will depend on how strict the sanctions are because in case there is an embargo on imports from Russia, the potential rise in price could be phenomenal, given that it is the third largest producer of oil. The rupee is now down past the Rs 75/$ mark.

Fourth, the threat of inflation is real, again. The RBI had assumed that inflation would be 4.5 per cent next year and the Budget too was talking of it being in the 3-3.5 per cent range. Now, with the Budget not providing for higher subsidy on fuel as well as fertilisers and excise collections not assuming any cut in the duty rate, it does look like that the price hike in crude will be felt at the retail end. In Mumbai, for example, as we pay Rs 110 a litre for petrol, the cost to the refiner is Rs 48, with another Rs 4 going as agency cost. The excise rate is Rs 28 while the balance is VAT charged by the state. The price has not changed in the last couple of months, ostensibly due to the ongoing state elections and hence, it was expected even before this crisis that the price would be hiked.

Even with unchanged duty rates, 10 per cent increase in crude prices will lift the basic price to Rs 53-54 for the refiner and be reflected in an increase of 5-6 per cent in the final price. While this may not be very significant when it comes to the inflation index which is considered by the RBI, the pain will be palpable. In fact, the secondary impact will be sharper as freight rates increase, which gets embedded in the final price of all other food products too. Hence the situation is one of concern for us in India. The inflation impact will be sharper when looked at from the point of view of the WPI, where fuel products have a higher weightage in the index. Intuitively it can be seen that as there is a pass-through of this inflation to the final product, the price increase can get generalised even at the producers’ level.

Russia is not a major trading partner of India and hence, on the external side, there will not be a major impact. But due to the currency and price effects, there will be disruptions. The government and the RBI will have to reconsider their assumptions in case the situation persists for a longer period of time. If the crisis is defused by March-end, then it might be considered a passing shock. However, if it does persist, action may have to be taken by the government by lowering taxes and the RBI may have to start increasing interest rates sooner than expected. The immediate barometer of all such expectations is the bond market. Yields have started moving up after coming down, after the RBI policy. The 10-year bond has gone past the 6.75 per cent mark in the last few sessions, after going below 6.70 per cent. Therefore, there will be uncertainty for a longer period of time.

— The writer is Chief Economist, Bank of Baroda, and author of: Hits & Misses: The Indian Banking Story. Views are personal

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