Russia-Ukraine crisis: Rising crude oil prices put growth prospects at risk

The Indian economy may be heading towards an oil shock in FY23 with Brent crude crossing $113 per barrel on Wednesday, the highest in nearly eight years, due to disruptions in supply amid escalating Russia-Ukraine tensions.

The latest Economic Survey for FY22 projected economic growth at 8-8.5 per cent assuming crude oil prices at $70-$75 per barrel. The Economic Survey FY18 had estimated that every $10 per barrel increase in the price of oil reduces economic growth by 0.2-0.3 percentage point, increases wholesale inflation by about 1.7 percentage points, and widens current account deficit by about $9-10 billion.

Abheek Barua, chief economist at HDFC Bank, said rising crude oil prices might prompt him to lower his current GDP growth estimate of 8-8.2 per cent for FY23.

“Due to prevailing uncertainty, we are working with scenarios. My sense is that by the second half (October-March) of FY23, the oil problem will be under control and oil will be in a reasonably lower band. If crude oil remains in the range of $82-85 per barrel in the second half, then my GDP growth number works out to 7.8 per cent for FY23. In the second scenario, if oil remains at around $100 per barrel, then we have to revise it down to 7.3-7.5 per cent. Much of the hit will come in the first quarter of FY23, which was actually pulling the overall GDP growth number up because of lingering base effect. That will have to be revised down significantly,” he added.

When oil and commodity prices harden, economic growth is impacted through both primary and secondary channels. With rising input costs, the margins of companies get squeezed, which gets directly reflected in GDP growth as it is calculated on a value-added basis. If companies pass on the prices to end consumers, then disposable income of consumers reduces, impacting overall consumer demand and, thus, GDP growth. Through the secondary channel, with rising inflation, the Reserve Bank of India may increase interest rates, which may make borrowings expensive adversely affecting both consumption and investment. If the government partly absorbs the rise in fuel prices, it may have an impact on its capex push, thus affecting growth momentum.

DK Joshi, chief economist at CRISIL, said rising crude oil prices will surely prove detrimental for economic growth. “The question is how high and for how long crude prices will remain elevated,” he said.

A prolonged war could also impact economic growth in other parts of the world, especially Europe, which is heavily dependent on Russia for energy supplies. This may impact India’s growth as the European Union is India’s largest export destination. Though Russia-India trade is not very large, escalation of logistics cost due to the ongoing geopolitical tensions could also affect India’s growth through trade channels.

Madhavi Arora, lead economist at Emkay Global Financial Services, said the current geopolitical escalation might lead to potential global energy trade and price disruptions and weigh on growth. “Higher oil prices can impact growth through multiple channels — higher inflation erodes purchasing power weighing on consumer demand, lower corporate profit margins due to rising input costs, and deterioration of twin deficit,” she added.

Upasna Bhardwaj, senior economist at Kotak Mahindra Bank, said in a report on Monday that while she retains FY23 GDP estimate at 8.1 per cent, the lingering geopolitical risks and its impact on various raw materials and commodities remain key risks weighing on the growth prospects. 

“If crude oil prices were to sustain around US$100/bbl, we could see 45-50 bps of downside risk to our base case GDP growth estimate,” she added.