How Russia-Ukraine conflict has impacted global and Indian economy

The Economic Survey of 2021-22 projected India’s GDP growth at 8-8.5 per cent for this financial year. This forecast was later revised to 7 per cent in the first Advance Estimates with no signs of the Russia-Ukraine war, which had broke out 24 days after the Survey was presented in Parliament, ending.

The Survey was not the only exception. All forecasters — from the Reserve Bank of India (RBI) to the International Monetary Fund and the World Bank — went wrong. None of them had expected Russia to invade Ukraine, despite the tell-tale signs.

India wasn’t directly impacted by the war: Its trade with Russia before the conflict was largely limited to the defence sector; its trade with Ukraine wasn’t significant either. Following the conflict, bilateral trade between India and Russia, in fact, surged as New Delhi sourced discounted crude oil and other items from Moscow.

The indirect impact of the war on the Indian economy, however, was palpable as it partly led to a recession or a severe slowdown in advanced economies, besides jacking up commodity prices in the initial phases. 

Inflation

The retail price inflation remained above the RBI’s upper tolerance level of 6 per cent for much of 2022-23 (except for November and December). The heightened commodity prices because of the war did not impact the consumer price index (CPI)-based inflation rate directly, except for fuel (petrol and diesel). For most other commodities, the impact was first reflected in the wholesale price index-based inflation rate, before it got transmitted to CPI.

Global prices of the Indian basket of crude oil remained over $100 a barrel until July and have since receded. These, in fact, slipped below $90 a barrel after October, on average, with global demand shrinking.

This holds true of other commodities, too. For the initial months, global prices, particularly of commodities supplied by Ukraine and Russia such as wheat, sunflower oil and fertilisers, skyrocketed, forcing India to take fiscal and monetary measures. These included raising of the policy rates, reducing excise duty and value-added tax on petrol and diesel, banning the export of wheat, restrictions on flour, suji and maida exports, a 20 per cent export duty on various kinds of rice, exemption of crude palm, soybean and sunflower oils from basic Customs duty, and a reduction in Customs duty on refined soybean and sunflower oils. The government had to revise-up fertiliser subsidies — from Rs 1.05 trillion in Budget Estimates to Rs 2.25 trillion — as the war jacked up prices globally.

Of late, though, commodity prices have been falling in global markets. The spike in CPI-based inflation from 5.72 per cent in December to 6.52 per cent in January had more to do with domestic factors, such as delay in wheat arrival in the markets, lack of fodder for milk, etc.

“We cannot really relate the Ukraine war with high inflation in India now, because global prices (of most commodities) have receded to pre-war levels,” said Madan Sabnavis, Bank of Baroda’s chief economist.

Balance of payments

External conditions deteriorated due to the war on many fronts. Demand in advanced economies slumped and the initial trade deficit was high due to the rise in imports even as commodity prices flared up. Otherwise, merchandise exports were up 20-30 per cent YoY in the February to June period. Thereafter, merchandise exports growth slowed down and exports even contracted in October, December, and January. Now commodity prices have declined, pulling down import growth in value terms. As a result, the trade deficit stood at a one-year low of $17.75 billion in January.

 The current account deficit (CAD), which also includes balance in services and other net receipts from the external world, rose to 2.8 per cent of GDP in April-June (FY23), against 1.5 per cent in January-March (FY22). The CAD would have been starker as the trade deficit ballooned to $68.6 billion, from $54.5 billion, but services surplus and remittances blunted the impact.

There was also pressure on the rupee vis-à-vis the dollar as central banks in advanced economies raised interest rates to fight elevated inflation. The rupee, which stood at 74.45 against the dollar in January 2022, weakened to 76.21 in March after the start of the war and breached 80 in September; it stayed over 80 in January and February of 2023. This resulted in a flight of portfolio investments.

Despite net foreign portfolio outflows of $14.6 billion in Q1FY23, there was net accretion to foreign exchange reserves of $4.6 billion as foreign direct investments (FDI) remained robust at $13.6 billion; also, there were inflows because of non-resident deposits and external commercial borrowings. The situation changed in July-September in 2022-23 as the trade deficit widened further to $83.5 billion. The CAD rose to 4.4 per cent of GDP. Together with widening capital outflows, this resulted in the depletion of forex reserves by $30.4 billion.

Economic growth

Various entities had to revise down their growth estimates for the world economy and, in turn, India’s economy. This was also a result of soaring inflation at that time, which forced global central banks to raise interest rates to control it. 

For instance, the IMF predicted world economic growth at 4.4 per cent for 2022 versus an estimated 5.9 per cent in the previous year. Its latest world economic outlook update expected growth at just 3.4 per cent for 2022. Though fears of a recession in the advanced world have receded, prompting the Fund to raise its projections compared to October by 0.2 percentage point, the latest prediction was nonetheless 1 percentage point lower than the one made before the war. Similarly, the IMF believed India would grow by 9 per cent in 2022-23 in its pre-war projections; it now expects 6.8 per cent growth. IMF projections now are even lower than 7 per cent as per the Advance Estimates.

 “There are several moving elements and uncertainties globally: Ukraine conflict, high inflation, monetary tightening, oil price volatility, and commodity price volatility, among others. Projecting GDP in such an uncertain scenario is a challenge for any agency,” said Ranen Banerjee, partner, economic advisory services, PwC.

However, the fact remains that the war, along with other factors, slowed down the world economy and hence the Indian economy, too. Going forward, economic growth would depend on how fast the Russia-Ukraine conflict de-escalates, behaviour of commodity prices, and inflation.