How geopolitical spill overs will impact Indian economy

27 Jun 2022 , 09:34 AM

Geopolitical risks have been elevated globally, ever since Russia invaded Ukraine. This was followed by a slew of sanctions imposed by the US and UK on Russian oil and other minerals. Things have become tighter with EU also joining the fray and agreeing to fully boycott Russian oil and gas from December 2022. Not surprisingly, Russia has retaliated and that has pushed the EU and the world to the throes of an energy crisis. Experts have called it the Lehman moment for global energy. How will it spill over on to the Indian economy?

Addressing the PHD Chamber of Commerce and Industry (PHDCCI) on this subject, the RBI deputy governor, Michael Patra, underlined this reality. According to Patra, the fallout of this geopolitical conflict had the potential to snuff out a recovery that was haltingly making its way in the Indian economy. Patra not only spoke about the magnitude of the spill over, but also outlined the measures taken by the RBI on the monetary front to address this issue.

India remains an island of growth

At last count, with World Bank downgrading global GDP growth to 2.8%, India remained the sole large economy poised to grow at above 7%. Despite the Omicron-driven third wave, the truth is that India is decoupling from the rest of the world and carving out a path of recovery. This was evident from the high frequency data points like the GST collections, e-way bills, advance tax numbers, PMI manufacturing, PMI services as well as the freight and cement numbers. In the latest monetary policy, the RBI toned down the growth estimates for FY23 to 7.2% (still lower than the World Bank estimates of 7.5%), but upped the inflation target to 6.7% for FY23.

What did change in the last 2 months is the tone and the stance of the monetary policy. Till the April MPC meet, the monetary policy was single minded in its pursuit of growth and recovery at any cost. However, since May 2022, the RBI turned hawkish. It not only hiked repo rates by 90 bps in 2 tranches but also hiked the CRR (cash reserve ratio) by 50 bps to 4.5%. The primary mandate now is price stability over the medium term, while sustained economic recovery has become a secondary objective. The argument of the RBI has been that if lower growth was unfair then high inflation was unjust. Of the two the latter was a worse problem to have. However, the X-factor was geopolitical tensions.

Emerging markets are bearing the brunt of geopolitical risk

As Patra rightly pointed out, the emerging markets (including India) were bearing the brunt of the geopolitical risk in more ways than one. Firstly, the global war situation has resulted in a combination of supply chain constraints widening the gap between demand and supply. This has led to commodity inflation of a very high order. Secondly, financial markets have become turbulent. Most global fund managers are adopting a risk-off approach. That means; they prefer the safety of developed markets to the high returns of emerging markets. The third impact is in the form of growth pressures. A spate of rate hikes is likely to lead to recession in the US with its spill over effect on India and other EMs. That will constrain demand and impact Indian exports, technology spending etc. As Patra put it eloquently, despite being bystanders, EMs like India are bearing the cross.

For the Indian economy, there are larger concerns. The capital outflows and the rising current account deficit are putting pressure on the Indian rupee. The INR has weakened beyond 78/$ and currency analysts are pegging it closer to 80/$. The war in Russia and Ukraine resulted in global shortages forcing India to pay more for the import of crude oil, fertilizers, coking coal and other industrial and agricultural commodities. The recent crisis in palm oil is a classic example of how this contagion has spread to agriculture too.

Fortunately, India has its buffers

The good news is that India has a reasonable number of buffers against geopolitical risk. Firstly, Indian economy is largely an inward looking and domestic demand driven economy. It is not like southeast Asian economies that are overly dependent on global trade to boost their economies. Secondly, India’s forex reserves are relatively comfortable, despite falling 8% from the peak to $596 billion. The forex chest is sufficient to cover 9-10 months of merchandise imports and the situation is a lot more comfortable if you also add the surplus in the services trade. Thirdly, even amidst commodity inflation and rising operating costs, the profits of Indian companies have grown strongly in the March quarter. That is likely to continue in the next few quarters too.

For a vast and complex economy like India, ample production and availability of food grains is the best hedge against any eventuality. In the year 2021-22, foodgrain production touched record levels for the 6th consecutive year. This has ensured food security even in the midst of widespread global shortages. The stock of rice and wheat stood at 3.7 times and 4.2 times respectively of the quarterly buffer norms. An important factor in this chaos is the availability of Russian oil at much cheaper rates. India has taken a stand to extend full support to the Russian economy and buy oil at deep discounts. That is likely to give the Indian economy a natural buffer against the spike in global inflation.

Monetary policy could be a double edged sword

Patra has however warned that the tight monetary policy adopted by the RBI could be a double edged sword. It is likely to take its toll on spending and demand. That is the price you pay for stability. The idea is to stabilise the price situation when the economy can still bear the shock. But the million dollar question is whether these monetary measures will get the better of inflation? After all, geopolitics is something India has little control over.

Patra give a counterview. The very fact that inflation is high and broadening means there is demand to afford such high prices. More than prognosticating, this is the time India can still afford to tighten, which is what the RBI is doing. Today, the assumption (and rightly so) is that growth is unambiguously impaired when inflation goes beyond 6%. Tightening now will not only keep the credibility of monetary policy but also boost growth in the medium term and help to stand up to the global contagion. That is good enough!