Sanctions and Cap Conundrum - Impact on India
-Siddhartha Roy,Former Economic Advisor, Tata Group

With the winter approaching, the key question before Europe is whether they want to keep the heating system on or brood over a future without Russian presence in a cold and dark Christmas night. The Ukraine-Russia conflict has made it apparent, that unless the people are willing to make a sacrifice for a war in someone else’s land, then socio-economic consequences can be quite grim. This is true for the Governments across Europe and the developing countries which are net importers of oil and gas.

G-7 which concluded its meeting recently with a proposal to put a cap on Russian oil and gas prices desperately wants India on board for their proposal to succeed. The basic idea of this proposal is to constrain Russia’s ability to fund the war by restricting its earnings. The implicit assumption is Russia will continue to supply oil and gas to G-7 and others as long as the cap is a little more than the marginal cost of production.

Once again the G-7 countries have gone wrong in their behavioural assumptions, Russia has made it abundantly clear that it will shut off the tap for any country that joins the “cap proposal”. For most of the European countries there is no alternative to Russian gas for the winter of 2022. Building up alternative approaches with other suppliers in such a short span of time won’t be easy.

When sanctions were introduced at the beginning of the Ukraine-Russia conflict, it was envisaged that the steps would reduce Russian “rouble into rubble”, the interest rates would go up very significantly, GDP would drop by 15% or there about, etc. However, the observable results are Rouble has become stronger, interest rate increases have been reversed, earnings from oil and gas have gone up significantly as international oil prices escalated.

Notwithstanding Ukrainian claims, IMF estimates show that GDP decline would be restricted to 6 to 8% and not 15% as estimated earlier. Even the consumer goods supply seem to be adequate, in fact from the additional earnings due to higher oil and gas price has enabled Russia to fund a significant increase in state pensions.

In this context, it may be worthwhile to look at the developments in USA, UK and EU. Inflation in most of these countries are in the 8.5% to 9% range, in UK it has already crossed 10% level. A part of it has been buttressed by higher energy prices, the rest is due to higher food and transport services prices. On top of it, recession is almost on the anvil, the post covid recovery has got stunted in most of the countries in this group. Erosion of real income due to inflation is further adding to social unrest. Ironically the objective of sanctions was to impoverish Russia and thereby encourage the Russian people to bring about a change! In fact, the effectiveness of sanctions as a tool of economic warfare needs better understanding.

In economic warfare gaming the assumptions about the opponents behavioural reaction is quite important. G-7 policy advisors possibly expected that a spin-off effect of the cap will be a reduction in overall energy prices and inflation in USA, EU and UK. The Russian reaction has been to shut off the gas supply from Nordstream-I under the pretext of a technical snag. This could create a major spike in the international gas market unless negotiations take place immediately with Russia. The Russian spokesman has already hinted at the removal of sanctions as the precondition for further discussion. While sanctions against Russia may not be removed; some adjustments will have to be made, particularly when a winter of discontent is almost staring in the face of EU. Interestingly EU is largely made of liberal democracies which cannot ignore adverse public opinion. Were they a totalitarian regime they possibly could have remained adamant.

The energy situation post covid tends to indicate that the demand for energy both coal, oil and gas have gone up . However, with not much fresh investment being made during the covid years and with emphasis on renewables no major spurt in supplies is foreseen in near future. On top of it sanctions against Venezuela and Iran have kept them out of the oil and gas market. OPEC+ after agreeing to increase supply have again cut back on oil production by 100,000 barrels a day. Given, this scenario it is indeed difficult for the leadership of democracies to take a rigid stand about “price cap” if it threatens supply of oil and gas for their consumers and industries. For a net oil importer like India to join a G-7 price cap regime is clearly detrimental to her own interest.

Firstly, India and some other countries get oil and gas at a discount of fifteen to twenty dollars. Secondly, there is an assured supply. It is indeed true that European insurance and reinsurance companies would sanction Russian deals which are above the G-7 cap. The alternative is for Indian, Chinese and Russian insurance companies to step in. A Russian re-insurance company supported by the Russian Government is already providing re-insurance. Oil and gas are considered strategic supplies by any Government so the necessary support is always forthcoming. In this Scenario, the Indian stand to play for time by pointing out the need for surety of non-Russian supply is indeed sensible. After all what matters to India is the sustainable economic growth of the country, lower inflation, a manageable current account and fiscal deficit. Every country or economic block looks after its own interest, why should there be any judgemental issue when India does that? Finally, Indian democracy is an effective bulwark against expansionist totalitarianism in Asia, weakening its economy by nudging it to join G-7 price cap framework is detrimental to all democratic interests.

Siddhartha Roy is the former Economic Advisor of the Tata Group. Currently he is the CEO of SR Associates an Economic Advisory and Strategic Consultancy enterprise.

Disclaimer: The opinions expressed in this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of Indiastat and Indiastat does not assume any responsibility or liability for the same.

indiastat.comSeptember, 2022
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