Why the Russia-Ukraine conflict could impede the recovery of Asia's third-largest economy

India, the world's third-biggest oil importer, already struggling with high commodity prices and inflation, had barely started recovering from the Omicron wave of coronavirus

A worker carries a sack of rice at a wholesale grain market in Uttar Pradesh, India. Rice is the latest commodity to get swept up in the Russia-Ukraine conflict. Bloomberg
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The Russia-Ukraine conflict is expected to hamper India's economic recovery, pushing prices of goods higher, including fuel and food, and stoking inflation.

GlobalData this month lowered its economic growth forecast for India by 0.1 percentage point, to 7.8 per cent for 2022, owing to Russia’s military offensive in Ukraine.

“A rise in commodity prices will add to the current account deficit, tighten financial conditions and lead to a possible depreciation of rupee against the US dollar,” says Gargi Rao, the economic research analyst at GlobalData.

“The investment climate might deteriorate and shock to stock markets will further lead to decline in capital inflows.”

Russia’s military offensive in Ukraine has dampened the prospects for the global economy, amid the geopolitical risks as many countries impose sanctions on Russia.

The conflict in Ukraine, and the and the subsequent sanctions imposed on Moscow, will have a "severe impact" on the global economy, the International Monetary Fund said on Saturday.

As the world's third-biggest oil importer, India is particularly vulnerable. Rising prices are a major concern for the Asia's third largest economy at a time when its energy needs are increasing and the government has mapped out high-spending plans in an effort to jump-start the economy.

“Higher oil and commodity prices and disruption in global supply chains consequent to it are capable of impacting growth in the near term,” says Amnish Aggarwal, director of institutional research at stockbroking firm Prabhudas Lilladher.

“We also import barley, sunflower oil, and other commodities [from Russia and Ukraine].”

Russia is among the world’s largest producers of wheat, barley and other commodities.

“The stand-off throws a spanner in the works of an economy that has barely started trudging towards recovery,” says Nirav Karkera, head of research at Fisdom, a finance company in India.

“The cumulative effect can be expected to moderate India’s GDP [gross domestic product] growth prospects with its strong sensitivity to sustained commodity inflation.”

This comes as India's economy recently suffered a setback due to the Omicron wave of coronavirus infections, which prompted authorities to impose fresh Covid-19 restrictions.

Gopal Krishnan, director, global development, South Asia at Risk Management Society (Rims) says “the risks that the world is now exposed to, is only multiplying the already existing pandemic risks and concerns”.

A recent forecast released by the Indian government shows the country's GDP expanding by 8.9 per cent in the current financial year to the end of March, down from its forecast of 9.2 per cent just last month.

India has been trying to get its economic growth back on track since the pandemic hit the country in 2020. The government had imposed one of the world's strictest nationwide lockdowns, pushing the nation into a historic recession.

India’s economy has been recovering as curbs were lifted, but the country was already struggling with high commodity prices and inflation, which is only likely to be exacerbated by Russia’s military offensive in Ukraine.

The latest quarterly data released last week showed that India's GDP growth momentum slowed from the previous two quarters to 5.4 per cent in the three months to December. This was partly due to the fact that previous quarters were rebounding from a lower base during the same months in 2020.

“The war has come at a time when the Indian economy was just looking up after two years of a slump due to the impact of Covid,” says JK Arora, chairman and chief executive of Tradologie, a trade enabling platform for agri commodities.

“It has thrown both the global and Indian economies into chaos and uncertainty.”

India’s direct trade exposure to Russia, Ukraine and Belarus is low, at 1 per cent of total exports and 2.1 per cent of total imports, figures compiled by Japan’s Nomura show. The investment bank says that India has high dependence on certain products from these countries.

More than 11 per cent of India's total imports of edible oils and fertilisers are sourced from these countries, for example. Ukraine and Russia provide more than 90 per cent of India's sunflower oil imports. And more than 30 per cent of materials used in infrastructure projects are sourced from these two countries.

“Overall, despite India’s limited direct exposure, the combination of supply disruptions and the ongoing terms of trade shock will likely weigh on growth, but also result in a sharper rise in inflation, a wider current account deficit and a hit to fiscal finances due to higher fertiliser subsidies and a potential cut in taxes to shield consumers,” says Sonal Varma, managing director and India economist at Nomura.

The government is looking at alternate supply sources for both edible oils and fertilisers, but “these will be expensive”, she explains, while New Delhi is also working on a rupee-rouble trade payment arrangement to avoid disruptions.

The expected impact of the crisis on inflation could take a toll on consumer spending.

India's economy is driven by consumption, which has been struggling to bounce back from the effects of the pandemic, making the latest risks particularly worrying.

“On the demand side, consumption is the slowest to recover to pre-pandemic levels,” says Madhavi Arora, lead economist at Mumbai-based Emkay Global Financial Services.

“Income variance post [the] pandemic is high as purchasing power seems concentrated at the top [while] the broader consumer space has lower incomes and savings through Covid.”

“Corporates are likely to be in a wait-and-watch mode, especially as global uncertainty weigh on sentiments, demand and cost,” she adds.

SP Sharma, chief economist at Indian trade and industry body PHD Chamber of Commerce and Industry, says that “the Russia-Ukraine crisis has created uncertainty not only in prices of crude oil but also in most international commodities”.

Some businesses in India say they are already feeling the effects.

“The current situation is already getting reflected in higher coal, oil and gas prices, leading to an increased cost of energy. The prices of steel and zinc [are at an] all-time high for this month,” says M L Mittal, managing director of Bharat Wire Ropes, a manufacturing company in Mumbai.

“These high prices will increase the cost of our products and the same will be passed on to the consumer of wire ropes.”

Logistics companies in India are also bracing for the effect of rising fuel costs and disruptions.

“The economic impact of this will be an increase in oil prices, which will, in turn, trigger an increase in air and ocean freight rates all over the world,” says Lancy Barboza, managing director of Flomic Global Logistics.

“The world was still reeling under the unimaginable increases in ocean freight rates due to logistical disruptions arising from Covid, when this Russian-Ukraine conflict broke out.”

Oil prices surged on Friday, ending the week at multi-year highs as the conflict intensified.

Brent, the global benchmark for two thirds of the world's oil, rallied 6.9 per cent to $118.11 per barrel at the close of trading on Friday, its highest since 2013 West Texas Intermediate, the gauge that tracks US crude, was 7.4 per cent higher at $115.68, the most since 2008.

The ripple effects of higher commodity prices will be felt across many sectors.

“The pharma industry also depends on different commodities such as crude oil and natural gas, which have a direct impact on transportation costs”, which could in the long run affect India’s economic growth, says Praveen Sikri, chief executive of Ikris Pharma Network.

The situation poses an enormous challenge for policymakers. Retail inflation in January breached the upper target set by the Reserve Bank of India, at more than 6 per cent. But at its monetary policy meeting last month, the country’s central bank kept interest rates on hold at record lows to support the economy. It said at the time that the India’s outlook for inflation was improving.

“Recent geopolitical developments have further aggravated the challenges and dilemmas for the central banks,” said RBI governor Shaktikanta Das, as he delivered a speech on Friday. “Central banks are in a bind.”

He said that if they aggressively hike rates “to contain inflation which may perhaps subside as normality returns, they run the risk of setting in recession; on the other hand, if they act too little and too late, they may be blamed for 'falling behind the curve' and may have to do a lot of catching up later which will be detrimental to growth”.

Updated: March 07, 2022, 6:02 AM