The coming storm

Russia-Ukraine fallout for India may be severe

The Russian Federation’s invasion of neighbouring Ukraine has spooked markets, investors, and economic policymakers worldwide, but India might be among the economies most exposed to any sustained turbulence. The rupee has already sunk to a new record low, and is close to about Rs 77 to the dollar. It declined by as much as 1.1 per cent on Monday alone. The rupee is now Asia’s worst-performing currency in 2022, in spite of apparent attempts to manage the fall by the Reserve Bank of India (RBI). Stock markets have also been jittery, with the Sensex falling 2.7 per cent to its lowest closing since the middle of last year. Given that crude oil has touched $130 a barrel, and there are fears that it may spike up to beyond $150 and even perhaps $200 within a few weeks, depending upon the progress of the war, the fears expressed through these numbers about the weaknesses in the Indian economy are quite understandable.
 

An increase in commodity prices leads to a familiar set of pressures on an economy that imports 85 per cent of its oil requirements. The Union Budget calculations, predicated this year on oil being at below $75 a barrel, are no longer reliable. Real growth will be lower than predicted based on the supply shock, and so the targeted fiscal deficit as a percentage of gross domestic product will become difficult to manage even if nothing changes in terms of government expenditure. But, on top of that, the government might seek to absorb some of the extra cost of fuel in particular, which will adversely impact its tax revenues; and meanwhile, the state of the markets means that its receipts will be under pressure as, for example, the disinvestment of the Life Insurance Corporation gets postponed. A precarious fiscal situation on exiting the pandemic will suddenly become much worse.

Meanwhile, the RBI will be faced with a currency under significant pressure. Pressures from New Delhi to support growth and also manage the sale of a large amount of government paper will become overwhelming. Yields on 10-year government bonds spiked 7 basis points on Monday to close at 6.89 per cent. There is still room for yields to rise, and higher rates will make the debt management job tougher. Meanwhile, inflation will be driven higher not just by crude oil prices but also those of edible oils — and it is already out of the RBI’s comfort zone. Sunflower oil has risen in price and is likely to rise further, given that Ukraine and Russia produce four-fifths of the traded sunflower oil in the world. There will be very little the central bank can do in the face of such a supply shock to avoid the double whammy of stalling growth and high inflation. The evolving situation will make policy choices more difficult for the RBI. The government, however, must be prepared to deal with the sort of headwinds that last hit India in the 2012-13 period, when high commodity prices and weak growth combined to hit the currency, inflation, growth, and the external account simultaneously. The focus must be on steady policy to ride out the storm.