The Russia-Ukraine conflict has rattled the markets, and the level of uncertainty has increased at a time when the world economy looked poised for a recovery. The markets were looking at the Federal Reserve increasing rates multiple times with the rollback of QE. This optimism has gotten punctuated with this war. What does this mean for us?
The direct impact on India will be limited to the extent of the trade between the two nations. The share of Russia in India’s total trade is just about 1%, and would not make much of a dent. In fact, a large part of the imports are defence-related, where the government can work out ways to ensure that the deals carry on. It is, however, the indirect impact—through the markets—that is a major concern.
The first point of contact is inflation. Commodity prices have started rising since the verbal assault began in early February. Crude oil impact is probably the most obvious one, but the war has been pushing up prices of metals, gas, edible oils right when it was expected that prices would remain stable this year after a bull run in 2021. Interestingly, in India, manufacturers had started increasing prices and passing on the higher input costs gradually since late December. Now, with this fresh round of increase in prices, the pressure will build across the board. The Indian government had desisted from increasing the price of fuel products since November, keeping an eye on the state elections. This round of price increase was expected even without the war. The present circumstances only exacerbates the situation.
The second area of concern is the rupee. The start of the war has lent a high degree of volatility to currencies across the world. A combination of war and sanctions has led to currencies coming under pressure, and the rupee has not been spared. This comes at a time when the current account balance had turned deficit-wards and,with oil prices going up, a higher CAD can be expected.
FPIs were already jittery given the tenuous situation regarding the next move of the Fed. The present situation has made such investment fickle as there has been the usual case of flight to safety with the dollar and gold benefiting from the present tension. Normally, gold and dollar go in different directions, but this time, they are headed the same way.
Third, the higher demand for dollars has meant that bond yields have also turned volatile. Yields have been falling on expectations that the Fed may not go in for a rate hike under these conditions. But, signals indicating that this would continue as inflationary fears get even starker are driving rates up. Hence, the daily volatility in bond yields has kept markets guessing. In India, however, the direction is clear—upwards. Post the credit policy, it was believed that RBI would not go in for rate hikes this year. This made the 10-year bond revert to the 6.7% mark.
However, with the state elections coming to an end and the global price of crude moving towards the $120 mark, markets have been spooked. Add to this the fact that the government may just defer the LIC IPO means that there could be challenges on the financing of the deficit. This has pushed the 10-year bond to 6.85%. These constant yo-yo movements may be expected till there is more clarity on the intensity of the Ukraine situation.
Fourth, the payment issue has raised concerns for those dealing with Russia. With Russia being blanked out of SWIFT, exporters are in a quandary. Add to this the fact that shipping companies are reluctant to ferry goods to Russia. In an attempt to hurt Russia, all entities in different countries are affected as they are counter-parties to these transactions. At the government level, India can enter into a rupee-rouble agreement, but for the private players, receiving roubles for exports may not be that attractive.
Will growth slow down? While there is no immediate threat for an economy, which is driven by mainly domestic demand, the secondary impact through all these market reverberations will be felt on the economy. Higher prices will definitely come in the way of demand and consumption. High inflation will also pressurise the MPC to review its stance on policy as it cannot be passed off as being transitory. Higher interest rates will go with inflation and the currency will stay volatile.
RBI may have to go in for more of the sell-buy swaps to steady the rupee. Uncertainty and a modicum of turbulence will mean more central bank intervention at some point of time.
The writer is Chief economist, Bank of Baroda. Views are personal.
