Ukraine crisis could stall economic recovery

Sushma Ramachandran

Senior Financial Journalist

The conflict raging in distant Ukraine is having repercussions around the world. The fallout is seen here too as soaring global oil prices are worrying while stock markets are rocked with volatility owing to fears of economic disruption. The immediate impact on the world economy has been a spike in crude oil prices beyond the psychological mark of $100 per barrel, while gas prices have shot up equally rapidly. Metals prices are ruling at a multi-year high on the prospect that key supplies may be stalled from Russia. Even European countries imposing sanctions are well aware that these are a double-edged sword. For instance, Germany’s move to stop certification for the Nord Stream 2 gas pipeline, which bypasses Ukraine, means preventing a 10 billion euro project from going on stream. It is part of the pipeline network that has enabled Russia to supply nearly 40 per cent of Europe’s energy needs.

As for India, the immediate impact is of hardening world oil prices. These are expected to touch $125 per barrel in the near future. Contrast this with the assumption made in the budget that international oil prices would be ruling at $70-75 per barrel during 2022-23. Clearly, budgetary calculations will have to be reworked unless geo-political tensions subside rapidly. As of now, it seems evident that the oil marketing companies (OMCs) will have to raise petroleum product prices as soon as state elections are over. Technically, public sector OMCs are free to fix prices linked to international rates but effectively they wait for clearances from the administrative Petroleum Ministry. Hence, there was a pause in price movements as soon as electioneering began but the hiatus is not going to last long.

With India importing over 80 per cent of its consumption, the oil companies have no option but to raise prices of petrol, diesel and cooking gas. Otherwise, they could be saddled with huge under-recoveries on these products. Raising prices will inevitably fuel inflation which has already touched 6 per cent, the upper end of the band fixed by the Reserve Bank of India. The cascading impact of diesel prices, in particular, will accelerate inflationary pressures. And this, in turn, will motivate the central bank to drop its accommodative policy aimed at pushing growth, and move towards containing inflation. In such a scenario, interest rates will be pushed upwards.

The first measure that the government needs to take to curb the impact of ever-higher international oil prices is to cut excise duty on petrol and diesel. This may be a tough call, given that the budget looks forward to a leap in spending on infrastructure. On the other hand, revenues have been surprisingly buoyant in 2021-22, giving the exchequer some leeway on this front. The loss would be substantial as the petrol and diesel duty cuts last November led to a revenue loss of about Rs 45,000 crore for only five months of the fiscal. But a cut at this stage could halt the growing effect of spiralling fuel prices on the economy.

The second is to review the situation regarding the availability of key raw materials for agriculture and industry, as a result of the Ukraine crisis. Fertiliser availability is now problematic globally and India is no exception as Russia is a major source. The shortfall in sunflower oil imports, on the other hand, can be made up by alternative oils from other countries. A more serious situation could emerge in metals needed in a wide swathe of industries. In case supply disruptions affect availability from Russia, prices of aluminium and nickel are likely to shoot up. Though India is self-sufficient in aluminium, scrap has lately been imported in large quantities. Similarly, nickel is a key item required in many industries. Both metals have already risen to multi-year highs.

Prices of precious metals used for industrial applications like platinum and palladium, of which again Russia is a major supplier, are also on the upswing. Palladium, especially, has become a highly prized commodity in recent years, given its use in catalytic converters as well as hydrogen cells.

In this context, the issue of payments becomes relevant especially as western countries have barred the use of the international messaging system for financial transactions, SWIFT, by some Russian banks. Significantly, however, the system of payments for gas supplies to European countries continues without any disruption. In other words, sanctions are selective and are not being imposed in areas that could cause discomfort to European consumers.

To clarify, SWIFT or the Society for Worldwide Interbank Financial Telecommunications is a secure messaging system that enables rapid cross-border financial transactions. Blocking this system has been done earlier while imposing sanctions on Iran. The present sanctions exclude Russian energy transactions in non-sanctioned banks enabling oil and gas to flow into world markets. The careful exclusion indicates that India similarly needs to focus on its own economic self-interests just as the US and Europe have been doing while imposing sanctions. Fortunately, India can rely on rupee-rouble transactions as in the past to deal with most payment issues, though there are also alternative messaging systems available for use.

The outlook is not all bleak, however, for the Indian economy despite the Ukraine crisis. The first good news is that the deal between western countries and Iran to lift sanctions has almost been finalised, which will bring more oil into international markets. The availability of Iran oil could ultimately contain the hardening price trend in coming months.

Second, the disruptions in global supply chains could work to India’s advantage and enable higher exports. Analysts are already highlighting the gaps where India could become a bigger exporter. This includes commodities as disparate as wheat and steel products. Supplies of both could be disrupted from Russia and Ukraine.

Clearly, the conflict between these two countries has wide-ranging ramifications on economic growth in India as well as other emerging economies. There are definitely more negatives than positives right now. Savvy economic management is thus imperative to tackle the challenge of the rocky external environment. This includes taking rapid steps to cut oil taxes and ensuring easy availability of key industrial goods. Any delay in decision making could put the fragile economic recovery in jeopardy. 

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