Ukraine crisis aggravates inflation, growth concerns

Russia has brushed aside threats of crippling sanctions from the United States and its allies and gone ahead with its plans to invade Ukraine.  The military and political hostilities threaten to retard global economic growth, stoke inflation and undermine international institutions that enabled countries with differing ideologies and political systems to co-operate on global issues like tackling climate change, settling disputes peacefully, trading with each other quite freely and so on.

The United States and its allies have already announced initial rounds of punitive measures against Russian banks, leading companies and individuals making it difficult for them to deal with or raise finance from the western world.  The sanctions include export controls aimed at denying semiconductors and other high-tech products to Russia’s military and industries. More harsh measures to weaken the Russian economy may follow in the coming weeks but how effective these will be is anyone’s guess. Many European economies, especially Germany, that are closely integrated with Russia do not want stronger measures that will damage their own interests. The West, it appears, is willing to strike but afraid to wound.

Russia is one of the world’s largest oil producers and a significant supplier of industrial metals such as nickel, aluminium and palladium. Both Russia and Ukraine are major wheat exporters. Russia and Belarus are important suppliers of potash that is used as an input in the manufacture of fertilizers. Any disruption in supplies of these key materials will have an adverse effect on their prices.  Russia is the foremost supplier of natural gas to Europe.  In the event of even temporary suspension of supply of natural gas, many industries in Europe will face closure.

In recent years, the investments in mining fossil fuels have declined globally due to growing concerns. Some countries, notably Germany, have phased out nuclear energy. The output from non-renewable sources like solar energy and wind energy cannot meet the demand. So, even if countries like Saudi Arabia increase their output to make up for any tapering of supplies from Russia, it is more likely that the oil prices will remain high due to structural mismatch of supply and demand. The higher energy prices will flow into prices of other goods and services.  India imports over 80% of its crude oil requirements.

The fiscal and monetary measures taken during the pandemic by the rich countries, persistent supply side constraints and the continued disruptions in the logistics sector have already pushed up the commodity prices and inflation rates in the United States and Europe to levels not witnessed in several decades. The Ukraine crisis only makes the situation worse. Now, the Central Banks in these countries have to necessarily raise the interest rates and tighten the money supply, thus raising the costs of borrowings and constraining growth. So, the world is likely to see higher prices and lower economic growth in the coming months. That is not good news for Indian exporters.

India is better placed to withstand the impact of higher commodity prices, hardening of interest rates and economic slowdown in the rich countries but to underplay or wish away inflation would be a mistake. The government and Reserve Bank of India should work in tandem to closely monitor the evolving global situation and take suitable measures to control inflation and sustain the growth momentum. 

email:tncrajagopalan@gmail.com