Global crude oil prices topping $100 a barrel and singeing of stock markets following Russia’s attack on Ukraine will cast a shadow not just on India’s budget arithmetic, but also put to test the Reserve Bank of India’s deftness in continuing to support growth in the near term with inflation risks suddenly turning more grave.
To take stock of the evolving situation, Prime Minister Narendra Modi met Finance Minister Nirmala Sitharaman and other senior government functionaries Thursday. With economic recovery still nascent post the third wave of Covid-19, the new geo-political tensions and an extended military engagement could post hurdles to growth in India.
“The PM met senior government functionaries to take stock of the situation arising from the Russia-Ukraine conflict and its impact on India,” a government official said. With surging crude oil prices, the most immediate concern is on the price front – India’s inflation rate is expected to surge higher than most official calculations. An above trend inflation print may prompt the central bank to raise policy rates ahead of schedule, coinciding with the rate hikes that the US Federal Reserve is slated to undertake early summer.
The government is also worried that plummeting stock markets may put a spanner on its budgeted disinvestment push. “Will the government be fine to price it lower given the market conditions,” asked a fund manager. The government hopes to raise over Rs 50,000 crore by selling 5 per cent stake in the 100 per cent state-owned life insurer.
Brent crude prices topped $105 per barrel mark on Thursday for the first time since September 2014 after the Russian President authorised the military operation in the Donbas region in Ukraine. The Bombay Stock Exchange’s Sensitive Index, Sensex, crashed over 2,700 points, its biggest single-day fall in about two years. The Nifty nosedived 815.30 points or 4.78 per cent to end at 16,247.95.
While India’s trade with Russia has not yet been severely impacted by the rising tensions in the border region of Russia and Ukraine, prospects of wide ranging sanctions against Russia by Europe and the US loom large on bilateral trade. “The impact on India will be two-fold: higher crude oil prices will keep CPI inflation higher for longer, obliging the RBI to raise rates more than the two hikes we expected in Aug-Dec’22 — unless the government sharply cuts excise duties on petrol and diesel to contain fuel inflation; via the trade route, given that the EU is the biggest market for India’s exports: supply disruptions to the EU are also likely to generate greater demand for steel, engineering goods, etc., of which India is an alternate supplier, so the factors that caused India’s exports to outperform the world in 2021 will continue to hold in 2022, allowing exports to remain robust,” researchers at ICICI Securities said in a note.
Although India imports over 80 per cent of its oil requirement, its share in total imports is around 25 per cent. Rising oil prices will impact the current account deficit — the difference between the values of goods and services that are imported and those exported. The rise in crude oil prices is also expected to increase the subsidy on LPG and kerosene, pushing up the subsidy bill.
More importantly, for the NDA government, the surge intensifies the pressure on the state-owned oil retailers to hike retail prices. These hikes have been put on hold in the wake of the state elections and an increase is expected immediately after the polling is over. A calibration of the hike, officials said, is now a more complex task, given the cascading inflation impact that could follow in the wake of the anticipated rise in prices.
The rise in crude prices poses inflationary, fiscal, and external sector risks. Inflation could turn even more structural with high oil prices having a pass-through effect for other sectors. Crude oil-related products have a direct share of over 9 per cent in the WPI basket and, according to a report by Bank of Baroda chief economist Madan Sabnavis, a 10 per cent increase in crude would lead to an increase of around 0.9 per cent in WPI inflation.
In Mumbai, Sitharaman had earlier this week said that the Russia-Ukraine tension and a surge in crude oil prices “posed risks” to India’s financial stability. Higher fuel prices are expected to hit consumption, which is already subdued due to the pandemic.
Investor sentiment has also taken a beating over the last few days in line with rising crude prices. Foreign portfolio investors have turned net sellers and have pulled out a net of Rs 51,703 crore from Indian equities between January and February, leading to decline and volatility in equity markets. The rupee has dropped over 1.7 per cent against the US dollar from 73.8 on January 12 to hit 75.09 on Thursday. Fund managers said markets are likely to remain volatile in the near term over the geopolitical concern, with FII outflows already touching record levels.
Experts noted that while India’s exports to Russia could continue largely uninterrupted despite US sanctions, potential sanctions from the UN could have a much more significant impact on exports to the region. “We are worried about shipments being stuck, we don’t know how long it will stay at which port (during a conflict),” Ajay Sahai, Director General & CEO of FIEO said.
Russia is India’s 25th largest trading partner with exports of $2.5 billion and imports of $6.9 billion in the first nine months of FY2022. India’s key exports to Russia include mobile phones and pharmaceuticals while India’s key imports from Russia are crude oil, coal and diamonds. Tea is a major export item from India.
India’s exports to Ukraine were about $372 million in the April – December period led by pharmaceuticals and mobile phones, while imports worth about $2.0 billion are dominated by sunflower oil and urea. Together exports to both countries accounted for under one per cent of India’s exports in the first three quarters of this fiscal.
The tensions in Ukraine are particularly expected to impact prices of sunflower oil in India, given that Ukraine was the biggest source of imported crude sunflower seed oil for the country. In 2021-22 (April-December), India imported a total of $1.87 billion worth of crude sunflower seed oil, of which $1.35 billion was from Ukraine. In 2020-21, total import of the commodity was worth $1.96 billion, of which $1.60 billion was from Ukraine. Ukraine is also a major source of military spares for India’s predominantly Russian arms and equipment.