Economic consequences of the war in Ukraine

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How will the war in Ukraine affect the global economy and India’s growth? Higher energy prices, higher food prices, higher yields across the board, flight of capital from emerging markets and slower growth are the obvious threats. If Ukraine does not agree to accept the neutral status Russia seeks and abandons its plan to join the West’s military alliance, Nato, the war will drag on till Ukraine accepts defeat, while the West keeps up its pretence that economic sanctions are a substitute for deploying its troops to push Russia out of Ukraine. That would derail global growth, hurt India’s exports and hopes for robust growth in 2022-23.

Oil prices have zoomed to a 14-year high to cross $130 a barrel, before trending down, although Goldman Sachs forecasts spot crude prices to touch $135 in the current year. Gas prices have risen 30 per cent in Europe, following a threat by Russia to turn off the gas flowing to the continent via the Nord Stream 1 pipeline (that leaves the pipelines through Ukraine and Turkey still pumping Russian gas to the West). The US is shedding its abhorrence of dictatorship and negotiating with Venezuela’s sanctioned leader Nicolás Maduro to obtain Venezuelan crude to replace Russian oil, should the West block purchases of Russian crude. The beneficiary would be China, who would get Russian crude at a discount.

Also see: Live Coverage of the War in Ukraine

India, too, could get access to Russian crude, if it makes bold to buy Russia’s Urals grade oil, which many Indian refineries are perfectly capable of handling. So long as the West does not impose secondary sanctions on Russia — sanctions on any entity that deals with a sanctioned Russian entity — it is possible to deal with Russian oil companies. Even as several Russian banks have been sanctioned, cut off from dollar networks, some banks have been exempt to let Europe continue to pay for the gas and oil it buys from Russia. Secondary sanctions would make it impossible for Europe to pay for the fuel they buy and that would derail supplies.

China is the world’s biggest importer of oil. If it steps up purchase of Russian oil, it would cut back on purchases from elsewhere, releasing oil for Europe to make up for Russian oil, should the Europeans choose to give in to US pressure to boycott Russian oil. Oil is relatively more fungible than gas: it could be moved around in oil tankers, provided tankers can be found.

Also see: Big Oil already a victor from Ukraine

Gas is trickier. The only way to transport it outside a pipeline network, which cannot be built overnight in the absence of a genie like Aladdin’s, is to first liquefy it, fill the liquid into pressurised cryogenic tanks or containers for transport on LNG tankers and regasify it at the importer’s end. Liquefaction plants and the regasification facilities, too, call for the genie’s services to be built in a hurry. Since Europe buys 40 per cent of its gas from Russia, it cannot easily source that much gas from elsewhere, even if they are willing to pay a huge premium.

India’s oil import bill would jump, unless India buys oil from Russia. This would feed inflation, in tandem with rupee depreciation. If the dollar price of oil goes up by 20 per cent and the rupee depreciates by 10 per cent, the rupee price of crude would go up by 30 per cent, and refined product prices would go up even more.

This need not affect the exchequer directly. Subsidy on petroleum products has been curtailed significantly, and there are no elections around immediately to inhibit the passing on of the higher import costs into retail prices that consumers pay. The impact on the exchequer would stem from higher interest rates and slower growth, curtailing potential tax collections.

When the level of risk goes up in the world, normally footloose capital flees back to the safety of home. As in India, in other emerging markets, too, foreign portfolio investors have been dumping local assets and going back to the US, Europe and Japan, taking refuge in government bonds. The yield on 10-year bonds has gone up in the US and the EU. To the extent that interest rate differentials between the dollar and an emerging market currency plays a role in shaping the exchange rate, this upward movement of developed world interest rates puts pressure on emerging market interest rates to go up, too.

Also see: The Ukraine standoff should accelerate India’s push for hydrogen

Price rises arising from supply disruptions, holds economic theory, should not be squeezed out by higher interest rates. These higher prices must feed through, to force appropriate adjustments. Once these first-round adjustments have been made and the resultant price increases, including a rise in wages, begin to make themselves felt should policy rates be raised to squeeze demand and curtail further price rise. Theory and practice do not always match. In any case, higher interest rates and higher prices would curtail growth below what would have been possible in their absence. Nascent post-Covid recovery would be undermined around the world. That is bad news for everyone.

Ukraine is Europe’s food basket, producing lots of wheat, corn and sunflower seeds. Russia is a major producer and exporter of fertilisers, besides of metals like aluminium and titanium (the Ilmenite sand of Kerala, from which titanium is extracted, gets its name from the mountains, plains and lake, all called Ilmen, in northwest Russia, where the titanium ore is found in abundance). Food prices were already trending high when the war began in Ukraine. With trade and shipping from Ukraine’s Black Sea ports disrupted and farming interrupted, global wheat supplies are likely to be impacted for two seasons. Fertiliser shortage would add to global food woes.

India has a silver lining in this, though. It has huge grain mountains to run down. Wheat stocks are at 33 million tonnes, against a buffer stocking norm of 14.5 million tonnes, including strategic reserves, for April. India can safely export 20 million tonnes of wheat, provided wheat of good quality can be found in Food Corporation of India stocks. FCI often stores grain in the open with just a tarpaulin to cover jute bags of grain piled up as large heaps. No one needs to work harder than the sarkari norm for grain stored in such a cavalier fashion to spoil.

Higher wheat and corn prices would lead to a generalised rise in grain prices, and of chicken prices, too. Curtailing Ukraine’s sunflower oil exports would make edible oil prices rise, apart from crude oil prices. That would feed into food inflation. The RBI would be forced to increase its policy rates faster than it had planned to.

As foreign portfolio investors exit stock and bond markets, stock prices would tank and the yield would go up. As the RBI sells dollars from its reserves to meet a sudden surge in dollar demand, it would suck rupees out of circulation, pushing up interest rates.

Higher prices and higher yields would undermine growth locally and globally. Export growth would decelerate.

Also see: Why India should support Russia in its standoff with the West over Ukraine

India would do well to press the case, in whatever manner possible, for Ukraine to accept a neutral status, like Finland or Moldova. Reuters has recently carried a report on Moscow’s reiteration of its terms for cessation of hostilities: neutrality, recognition of Russian ownership of Crimea, and recognition of Luhansk and Donetsk as independent republics in the Donbas region. Notably, the Russian demand does not include a land corridor to Crimea from Russia that would have included key Ukrainian towns and regions that have been captured by Russian troops.

These are terms that Ukraine can accept, in return for security guarantees from Russia. India should urge the US and Europe to abandon their effort to extend Nato to Ukraine and deploy Nato missiles and troops less than 500km from Moscow. The range of a short-range missile is 1,000km. Ukraine under Russian occupation would mean Russian short-range missiles stationed in Ukraine having major European capitals under their constant gaze. A neutral Ukraine suits both Europe and Russia, security-wise, and, in terms of economic implications, the world.