As the world is watching the crisis brewing in the Ukraine and Russia, the ripple effects of these developments have already spread through the global economy. In case the situation worsens, countries like India which are in a fragile recovery phase owing to the pandemic may face further economic disruptions. Finance Minister Nirmala Sitharaman has rightly cautioned that geopolitical tensions could pose a risk to the country’s financial stability. She spoke in the backdrop of the stand-off between Russia and western countries have already led to a spurt in global crude prices. These have reached seven-year highs of 97 dollars per barrel. Expectations are the psychological 100 dollars mark could soon be breached as well. Other fall-outs of the conflict could emerge in the coming days including volatility in stock markets and inflationary pressures.
The first and most visible impact of the geopolitical crisis in Ukraine is the spike in world oil prices. This was already on a hardening trend for the last few months. The Organisation of Petroleum Exporting Countries (OPEC) and its allies including Russia, now known as OPEC plus, had earlier refused to raise output further to meet the demand that had begun rising last year as global economies reverted to pre-pandemic levels of commercial activities. It had decided to increase production by 400,000 BPD (barrels per day) every month from September 2021 onwards as a measure to increase oil supplies. But this did not bring relief to oil markets as demand vastly outstripped output. Plus some OPEC members couldn't meet their production quotas, adding to the shortfalls in availability.
Output from shale oilfields in the U.S. was also lower than usual, partly due to maintenance issues and partly due to several hurricanes over the past two months that led to the closure of offshore oilfields in the Gulf of Mexico. The net result was that prices of the benchmark Brent crude were ruling at around 82 to 84 dollars per barrel by January. The relentless hardening of crude oil prices was not affected by appeals made by leading consumers like the U.S. and India to the cartel, urging it to raise output to stabilize the market. The next step taken by the U.S. and several major consumers like India, South Korea, and Japan was to release strategic oil reserves into world markets. This did not, however, had the desired impact though it did bring consuming nations together for the first time to form a united front against the oil exporters cartel.
With the worsening of the geopolitical scenario in Ukraine, prices are now continuing to rise inexorably. One reason is that if sanctions are imposed by western countries on Russian oil and gas supplies, demand would shift to output from other countries. Analysts are forecasting that prices will reach 125 dollars per barrel over the next few months though this is still lower than the peak of 147 dollars per barrel reached in 2008. The impact of such high prices on India can only be adverse as over 80 percent of its oil demand comes from abroad. The oil import bill will rise sharply in 2022-23 fiscal from this year’s expected level of about 110 billion dollars. Besides, one of the key assumptions in the Economic Survey was that international oil prices would remain in the range of 70 to 75 dollars per barrel during the year. Many of the estimates especially for import costs would have to be revised based on the fast-changing external environment.
In case world oil prices continue to rise as a result of geopolitical tensions, the government may have no option but to increase retail prices of petroleum products like petrol, diesel, and aviation turbine fuel. This will in turn fuel inflationary pressures that are already facing the economy. Inflation during January reached a seven-month high of 6 percent, touching the highest end of the central bank’s band. Even so, the Reserve Bank of India has so far maintained the status quo on interest rates in the interest of promoting growth. In case fuel prices are pushed up and create a cascading inflationary impact, it may have little option but to go ahead with an increase in interest rates, on the lines of central banks around the world.
While discussing oil prices, one must not forget that Russia is also a major metals producer, especially aluminum and nickel. It is the second-largest producer of aluminum in the world. No wonder then that aluminum is currently ruling at 11-year highs. Similarly, it is a major source of nickel production. This metal too is already ruling at multi-year highs. While India is one of the biggest aluminum producers, it still imports considerable amounts of aluminum scrap. The cost of nickel needed in critical sectors will also go up for the Indian industry.
And finally, the impact of the continuing tensions on the world stage will have an impact on the stock markets which are already facing volatility owing to the tightening of easy money policies in western countries. Notably, the decision by the U.S. Federal Reserve to raise interest rates has led to foreign institutional investors moving out of the Indian stock markets over the last few months. The volatility comes at a time when the government is planning to launch the LIC’s IPO into the markets, giving rise to fears that this may not be an ideal time to do so.
The geopolitical tensions in Ukraine and the prospect of severe economic sanctions by western countries on Russia are thus bound to have serious consequences for India as it is on the cusp of a recovery from the pandemic. The government needs to rework its strategies for pushing growth to 8 percent in the next fiscal, taking into account the altered global scenario especially rising oil prices. It can only hope that the crisis is resolved swiftly as otherwise, the ripple effects will create obstacles in the government’s well-laid plans for economic revival.