Concerns over budget calculations and growth as oil surges above $100 and markets crash
Global crude oil price above $100 per barrel and stock market boomThe aftermath of Russia’s attack on Ukraine will not only cast a shadow over India’s fiscal arithmetic, but will also test the ability of the Reserve Bank of India to continue supporting growth. in the short term, with inflation risks suddenly becoming more serious.
To take stock of developments, Prime Minister Narendra Modi met with Finance Minister Nirmala Sitharaman and other senior government officials on Thursday. While the economic recovery is still nascent after the third wave of Covid-19, new geopolitical tensions and a prolonged military commitment could present obstacles to growth in India.
“The prime minister met with senior government officials to take stock of the situation resulting from the Russian-Ukrainian conflict and its impact on India,” a government official said. With crude oil prices soaring, the most immediate concern is prices – India’s inflation rate is set to climb higher than most official calculations. A sense of above-trend inflation could prompt the central bank to raise policy rates sooner than expected, coinciding with rate hikes the US Federal Reserve is expected to undertake in early summer.
The government is also concerned that falling stock markets will put a damper on its budgeted divestment drive. “Will the government agree to lower the price given market conditions,” asked a fund manager. The government hopes to raise more than Rs 50,000 crore by selling a 5% stake in the 100% state-owned life insurer.
Brent crude prices rose above $105 a barrel on Thursday for the first time since September 2014 after the Russian president authorized the military operation in Ukraine’s Donbass region. The Bombay Stock Exchange‘s sensitive Sensex index tumbled more than 2,700 points, its biggest single-day drop in about two years. The Nifty plunged 815.30 points or 4.78% to end at 16,247.95.
While India’s trade with Russia has not yet been seriously affected by the rising tensions in the border region of Russia and Ukraine, the prospects for far-reaching sanctions against Russia by Europe and the United States occupy an important place in bilateral trade. “The impact on India will be twofold: higher crude oil prices will keep CPI inflation higher for longer, forcing the RBI to hike rates more than the two hikes we expected in August-December 22 – unless the government drastically reduces excise taxes on petrol and diesel to contain fuel inflation; via the trade route, given that the EU is the largest market for India’s exports: supply disruptions to the EU are also likely to generate greater demand for steel, engineering, etc., of which India is an alternative supplier, so the factors that made India’s exports outperform the world in 2021 will continue to hold in 2022, allowing exports to remain robust,” said ICICI Securities researchers in a note.
Although India imports more than 80% of its oil needs, its share in total imports is around 25%. Rising oil prices will impact the current account deficit – the difference between the values of imported goods and services and those exported. Rising crude oil prices are also expected to increase the subsidy on LPG and kerosene, driving up the subsidy bill.
More importantly, for the NDA government, the push intensifies pressure on state-owned petroleum retailers to raise retail prices. These increases were suspended following the national elections and an increase is expected immediately after the end of the polls. A calibration of the upside, officials said, is now a more complex task, given the cascading impact of inflation that could follow in the wake of the anticipated price hike.
Rising crude prices pose inflationary, fiscal and external risks. Inflation could become even more structural, with high oil prices having a transmission effect on other sectors. Crude oil-related products have a direct share of over 9% in the WPI basket and according to a report by Bank of Baroda Chief Economist Madan Sabnavis, a 10% increase in crude would result in an increase of about 0.9%. in WPI inflation.
In Mumbai, Sitharaman said earlier this week that Russian-Ukrainian tension and a spike in crude oil prices “pose risks” to India’s financial stability. Rising fuel prices should affect consumption, which is already subdued due to the pandemic.
Investor sentiment has also taken a hit over the past few days due to rising crude prices. Foreign portfolio investors became net sellers and withdrew a net amount of Rs 51,703 crore from Indian equities between January and February, leading to lower and volatile stock markets. The rupee fell more than 1.7% against the US dollar, from 73.8 on January 12 to 75.09 on Thursday. Fund managers said markets are likely to remain volatile in the near term due to geopolitical concerns, with outflows from FII already hitting record highs.
Experts noted that while India’s exports to Russia could continue largely uninterrupted despite US sanctions, potential UN sanctions could have a much greater impact on exports to the region. “We are worried that the shipments will be blocked, we don’t know how long they will stay in which port (during a conflict),” said Ajay Sahai, managing director and CEO of FIEO.
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 fiscal 2022. India’s top exports India to Russia include mobile phones and pharmaceuticals, while India’s main imports from Russia are crude oil, coal and diamonds. Tea is a major export product from India.
India’s exports to Ukraine amounted to around $372 million between April and December, driven by pharmaceuticals and mobile phones, while imports worth around $2.0 billion dollars are dominated by sunflower oil and urea. Together, exports to the two countries accounted for less than one percent of India’s exports in the first three quarters of this fiscal year.
Tensions in Ukraine are particularly expected to impact sunflower oil prices in India, given that Ukraine was the largest source of imported crude sunflower oil for the country. In 2021-22 (April-December), India imported a total of $1.87 billion worth of crude sunflower oil, of which $1.35 billion came from Ukraine. In 2020-21, total imports of the merchandise amounted to $1.96 billion, of which $1.60 billion came from Ukraine. Ukraine is also a major source of military spares for India’s mainly Russian weapons and equipment.