Safe for now, macro economy may take a hit if Russian-Ukraine war stretches

A feeble impact is already being felt, and if the conflict stretches way beyond March, it could have implications on growth, inflation, fiscal deficit and current account deficit

Many had thought Russia would conquer Ukraine within 10-15 days, but it has been a month since the war began. It still isn't clear how long it will take for peace to resume in the region even as Ukraine president Volodymyr Zelenskiy has made it clear that the country will not join the North Atlantic Treaty Organization (NATO). Prospects of Ukraine becoming a member is what drew Russia's ire in the first place.

The rupee hasn't dropped below 80 a dollar so far, as most experts have been fearing. Also, global crude prices crossed $130 a barrel in between but have since come down.

If the war continues beyond March and sanctions against Russia remain in place, India's economy may be adversely hit--a feeble impact is already being felt.

Economic Growth:

Asserting that he believed the war would ebb within 2-3 weeks, Bank of Baroda chief economist Madan Sabnavis saw the GDP growth at constant prices declining by up to 0.25 per cent during the next financial year, from his earlier projections of 7.75-8 per cent, if the invasion persists. This means he now sees GDP growth at 7.5-7.75 per cent. It should be noted that the Economic Survey had projected GDP at constant prices growth to be 8-8.5 per cent for the year.

Ranen Banerjee, leader economic advisory services, PwC, pointed out that if oil prices remain at elevated levels for six months, real GDP growth could come to a sub-seven per cent.

However for Budget numbers, nominal or GDP at current prices is more important. The Budget has assumed the country's GDP at current prices to expand by 11.1 per cent to Rs 258 trillion for 2022-23. However, it was based on the first advance estimates of GDP at Rs 232.15 trillion for 2021-22. The second advance estimates have pegged the GDP at Rs 236.44 trillion for the current financial year. At 11.1 per cent, the Budget assumption would give GDP at Rs 262.68 trillion.

When the Budget was tabled in the Lok Sabha last month, economists felt this 11.1 per cent growth rate was too conservative. It was still achievable because even if GDP at constant prices falls below seven per cent, say to 6.5 per cent, it would require deflators to be just 4.6 per cent. Deflators are nothing but the inflation rate, consisting of wholesale prices and consumer prices in the ratio of almost 75:25 per cent.

Inflation:

Banerjee said oil prices will be the key determinant of the impact on the economy. "There are two scenarios - the oil prices remain elevated at $100 per barrel or come down significantly," he said.

The reasons for a possibility of a sudden normalisation of oil prices is that alternative supply channels to replace Russian oil and gas are being pursued in parallel viz. Iran coming online, UAE and Saudi utilising higher capacity, US increasing its exports and shale production going up given the high prices, he pointed out.

"Under such a scenario, Russia could be forced or encouraged to sell crude at a discount to countries that will be willing to accept the same," he said.

In fact, Moscow has already offered crude oil and other commodities at a discount to New Delhi, according to reports.

Sabnavis said if the war continues beyond March, global commodity prices will rise, leading to higher import cost and imported inflation.

In fact, the consumer price index (CPI) inflation remained over six per cent in the first two months of the current calendar year. This was despite the fact that till March 21, the oil marketing companies had not raised prices of petrol and diesel since November. On March 22, they raised the price of petrol and diesel by 80 paise, but this may not be sufficient for them to recover losses. A few days back, they had also raised diesel prices by Rs 25 a litre for bulk buyers.

Reserve Bank of India (RBI) governor Shaktikanta Das felt the two-month bout of over 6 per cent inflation rate was transitory. He said the central bank's expectation was that it would moderate to 4.5 per cent.

The RBI's monetary policy committee (MPC), in its latest meeting in February, projected CPI inflation at 4.5 per cent in 2022-23 with that in the first quarter pegged at 4.9 per cent.

Wholesale price index (WPI)-based inflation rate, which has much higher share in deflators, remained in double digits for the 11th straight month. However, it was largely the result of a very low base of the previous year. Once the base gets into double digits April onwards, WPI inflation may come down purely on this technical basis.

Meanwhile, international prices of Indian crude basket stood at $108.25 a barrel by March 18 against over $130 on March 7 and $93.22 as on March 1. Though the latest prices are quite high compared to $83.5 in February on average and $72.93 in January, they are much lower than over $130 a barrel on March 7. Russian oil supply may bring it down further.

"A lot of development are taking place. Crude oil prices toiuched $130 (a barrel) and then came down to $99 and today (March 21, 2022) it is at $102. So, we really do not know how it is going to pan out," Das said.

Fiscal deficit:

The Centre will be spending a little more than Rs one trillion more compared to the revised estimates in the budget during the current financial year. Of this, about Rs 15,000 crore would be spent on fertiliser subsidy, which is under stress due to the ongoing war. Though the fiscal deficit would be taken care of by the buoyant tax revenues in the current financial year, the next year is also likely to see higher fertiliser subsidies.

The Budget Estimate (BE) for fertiliser subsidy is pegged at Rs 1.05 trillion for the next financial year. Policymakers are not willing to put a new number to it yet.

Sabnavis said the government's fertiliser subsidy will increase for sure.

The government has pegged the fiscal deficit at 6.9 per cent of GDP in the current financial year and 6.4 per cent for FY23.

As cited above, OMCs raised prices of petrol and diesel by just 80 paise a litre. However, to recoup their losses, OMCs must either raise the rates further or the government must cut excise duty.

"We have to take a call on how we tackle oil inflation--lower taxes or have consumers pay more or have OMCs absorb part of the burden," Sabnavis said.

Icrs chief economist Aditi Nayar expects a Rs 90,000 crore loss to the exchequer if the  Centre reinstates excise duty on petrol and diesel to the pre-pandemic levels before April 1, 2022, followed by the budgeted rise of Rs two/litre each on unblended fuel in the second half of the next financial year.

The Centre's fiscal deficit is pegged at Rs 16.6 trillion for the next financial year. A hole of Rs 90,000 crore in the revenue, if all of it comes from cess as it won't be devolved to the states, would widen the deficit. The only hope to bridge the deficit to the desired level would again be other tax revenues--direct taxes and GST.

CAD:

Nayar said that elevated commodity prices and pessimistic sentiments in global markets will impart a depreciating bias to the rupee against the dollar.  While this does not necessarily boost exports as competing currencies also depreciate, the impact of elevated commodity prices will add to the import bill.

This would only happen post March and once data on trade for the month is released, one would be able to gauge the full impact of the Russian-Ukraine war on trade deficit and current account deficit (CAD).

India imported $15.28 billion of petroleum in February, 27.76 per cent higher than $11.96 billion the previous month, despite the former being three days shorter. The impact on petroleum exports was also visible as these rose to $4.65 billion in February, 11.5 per cent higher than $4.17 billion in the previous month.

Overall imports rose slightly higher to $55.45 billion in February against $51.93 billion in the previous month, while overall exports remained almost the same at $34.57 billion in February against $34.50 billion the previous month.

Trade deficit was $20.88 billion in February, slightly higher than $17.42 in January but lower than $21.68 billion in December and $22.91 in November.

If one factors in the surplus in services trade of $8.56 billion, the deficit in goods and services trade stood at $12.32 billion in February. Surplus in services trade in January was much higher despite the Omicron effect at $11.07 billion. This narrowed the deficit in goods and services trade to just $6.35 billion. This deficit along with few other incomes will decide the trajectory of the current account deficit.

The widening deficit in goods and services trade in February as compared to January, despite fewer days, may not tell the entire story since the effect of the Russian invasion on Ukraine was felt only in the last week of February.

One has to see the March data to gauge this impact. Beyond March, if global crude prices continue at elevated levels, the CAD would widen.

India Ratings chief economist Devendra Pant said every $5 a barrel increase in the Indian oil basket will lead to $6.6 billion in CAD.

Nayar said if the price averages $130 a barrel in FY23, the CAD will widen to 3.2 per cent of GDP, crossing three per cent for the first time in a decade.

The country's current account was in surplus, at 0.9 per cent of GDP in the first quarter of the current financial year and had a deficit of 1.3 per cent in the second quarter.