Russian invasion of Ukraine and Budget 2022

While Russia's invasion of Ukraine doesn't quite throw Budget 2022 out the window yet, it does mean the fiscal maths will need a significant re-look.

Finance Minister Nirmala Sitharaman has had terrible luck with her budgets. Of the three she has presented, two have been rendered unworkable even before the start of their respective financial years.

Budget 2020 was, of course, blown away by the coronavirus (Covid-19) pandemic. Presented on February 1, 2020, there was no way to know how bad things were going to get even by April 1, let alone later that year.

What followed were several mini-Budgets that completely overturned any of the fiscal maths the Budget contained.

The Russian invasion of Ukraine this year has done something similar to Budget 2022, although not at the same scale. Fears of supply disruptions due to the conflict had pushed oil prices above the $100 a barrel mark within a day of its start. The price now stands at around $110.

As she has said in various interviews and press conferences since, the Budget had taken into account some sort of spike in oil prices. But the government is becoming aware that this war and its economic ramifications could last a lot longer than initially thought.

While that doesn’t quite throw Budget 2022 out the window yet, it does mean the fiscal maths will need a significant re-look. The real question now is how quickly the exercise can be completed.

According to ICRA, if Indian crude averages $100 a barrel through FY23, the current account deficit could rise to 2.3-2.5% of GDP. With crude at $110, that impact is likely to be worse.

The various assembly elections going on right now have meant that petrol and diesel prices have not changed since December 2, 2021. Any impact of rising oil prices are being borne by the oil marketing companies.

So the government has three real options before it now. It could continue to keep fuel prices in India unchanged and instead pay an increasing amount to the OMCs to compensate for their under-recoveries.

Or it could allow fuel prices to increase but reduce fuel taxes to offset the increase and protect the consumers.

Or it could do nothing and let the consumers bear the brunt. That’s not going to happen. There are too many elections on the way.

So the government is looking at either a significant (and largely unplanned) increase in its expenditure or a similarly significant reduction in its revenue, or both.

A higher fiscal deficit, could potentially lead to an outflow of foreign capital. If ratings agencies take a harsh view of things and downgrade India’s rating or outlook, this outflow is more than likely. August-December 1990 showed how quickly the capital can go out.

That said, it’s not just due to oil prices that India is facing ‘collateral damage’ from a war that has nothing to do with it.

Ukraine accounts for about 14-15% of all vegetable fats and oils that India imports, so expect a very sharp spike in those prices in the near term. Food inflation, already high, will be even higher.

The West’s removal of Russian banks from the SWIFT banking system has thrown into extreme uncertainty payments due to Indian exporters. Reports are already coming in that $500 million in dues to Indian exporters are stuck in Russia.

Similarly, other countries too are going to face significant distress for no fault of their own. Countries n the Middle East and North Africa stand to see basic foods such as bread become a whole lot costlier.

Turkey imports about half of the grain it consumes and 85% of these imports came from Russia and Ukraine. Similarly, Egypt and Tunisia respectively rely on Ukraine and Russia for 85% and 50-60% of their wheat imports.

Thus, just as countries were limping back to normalcy from a pandemic not of their creation, they are again being dealt a blow by somebody else’s war.