Managing a crisis: Russia-Ukraine war outbreak a setback for Indian economy

In the wake of Russia’s invasion of Ukraine, a year ago, there were fears that the Indian economy would experience heightened uncertainties in at least three specific areas. Dangers of higher inflation would pose new challenges for those in charge of managing India’s monetary policy. The possibility of higher commodity prices, particularly those of crude oil and fertilisers, would threaten the government’s fiscal consolidation plan. And the Indian economy’s external sector, it was feared, would come under pressure because of a rising import bill, even as exports might suffer on account of a likely global economic slowdown.

In January 2022, retail inflation had already touched 6 per cent, the upper tolerance level mandated under the Reserve Bank of India’s inflation targeting regime. Thanks to the Russia-Ukraine conflict and the consequent rise in commodity prices, retail inflation stayed well above 6 per cent for the next nine months. The Monetary Policy Committee of the Reserve Bank of India (RBI) reacted a bit late, after having brought down the repo rate (at which banks can borrow funds from the central bank) and maintaining it at 4 per cent for two years till April 2022.  In May 2022, in an out-of-cycle monetary policy review, the RBI raised the repo rate to 4.4 per cent and kept raising it at regular intervals. Between May 2022 and February 2023, the repo rate has seen an increase of 2.5 percentage points to 6.5 per cent.

With international prices of fertilisers rising, India’s subsidy bill for soil nutrients rose sharply. Against a budgeted fertiliser subsidy bill of Rs 1.05 trillion, the actual bill skyrocketed to Rs 2.25 trillion in 2022-23.  Responding to higher international crude oil prices pressuring Indian oil refiners and marketers to raise retail prices, the Centre in May reduced the excise duty by Rs 8 per litre of petrol and by Rs 6 per litre of diesel. While this helped bring down retail prices of these widely used petroleum products and prevent a further spike in inflation, the Centre’s excise duty collections, largely mobilised from these two items, fell by 19 per cent to Rs 3.2 trillion in 2022-23 over the previous year. Even though, compared with the budgeted excise collection target, the decline was lower at 4.5 per cent, the government’s revenue budget was adversely impacted.

On the external front, India’s exports at $369 billion in the first ten months of 2022-23 grew by just 8.5 per cent, compared to the robust 44 per cent growth recorded in the full year of 2021-22. Thanks largely to higher crude oil and fertiliser prices, India’s imports also grew by about 22 per cent in the April-January period of 2022-23. The growth was slower than 56 per cent registered in the full year of 2021-22, but the strains of a global economic slowdown and the war between Russia and Ukraine were showing in India’s trade balance.

Given such adverse macroeconomic challenges, the Indian government managed the fallout of the Russia-Ukraine conflict in a way that its overall impact on the economy was contained and even minimised. Inflation, reined in at around 6 per cent, was high, but not the kind of double-digit price rises that many countries witnessed. But the cost of money rose sharply, impacting investment and growth prospects. Indeed, sustaining growth in the coming months would be an onerous task.

Buoyant tax revenues, helped by the levy of a windfall tax on oil companies, softened the impact of lower excise duty collections and expenditure slippage on account of subsidies. This allowed the government to proceed on its fiscal consolidation path, albeit at a pace slower than what would have been a desirable level.

The trade deficit in the April-January period of 2022-23 widened by over 51 per cent, with exports growth at 8.5 per cent hugely lagging that of imports at 22 per cent. The deterioration on the trade account, however, could have been worse, but for the government’s smart geostrategic moves to secure crude oil supplies from Russia, at a price lower than that of Brent crude, and, more importantly, without incurring any sanctions or adverse action from the West. 

By January 2023, Russia became the top supplier of crude oil to India, with a share of over a fourth of India’s total import needs. This also improved the composition of the markets from where India traditionally meets its energy demand. In the April-December period of 2022, Russia’s exports of oil to India rose to $22 billion, up from $2.5 billion in the same months of 2021.

In sum, the outbreak of the Russia-Ukraine war in February 2022 was certainly a setback for the Indian economy, but its impact has been kept under check so far. Whether this remains under control in the coming months will, of course, depend on the future intensity and spread of the Russia-Ukraine war, and the effectiveness of the Indian government’s response.