Ukraine war and the subsequent developments like sanctions, etc. do not augur well for the global economy which is on a post covid revival track. The war has led to spikes in energy, wheat and commodity prices; apprehensions about higher inflation, elevated yields, volatile currency and lower GDP growth have rattled the capital market. Early signs of asset switch in favour of gold is visible. Given the intertwined nature of the global economy and the international supply chains most of the countries got affected by last week’s developments. However, the impact on different geographies would be different. It is well recognised that around 40% of Europe’s gas requirement and 26% of its crude oil requirement come from Russia. The country which is most dependent on Russian energy imports is Germany. While Europe has methodically put sanctions in place against Russia, the oil and gas has been kept out of it. Even in the SWIFT related sanctions of some of the Russian banks there is a curve out for the oil and gas sector. This has been done to ensure that European homes remain heated in winter, further there is no shortage of aviation fuel and fuel for cars. After all the political cost of fuel shortage leading to a sharp price escalation can be high for the ruling Government in a liberal democracy. Interestingly, UK gets 6% of its crude oil and 5% of its gas from Russia. This lesser dependence on Russia has enabled UK to take a more bolshie stand in the current context.
At this stage, it may be useful to point out that India-Russia Commercial trade is somewhat limited. According to International Trade Centre data 1.7% of all imports by India come from Russia and 1.3% of entire Indian exports went to Russia in 2020-21. It is indeed true that fifty percent of our defence imports come from Russia. However, here we are focused on merchandise trade alone. The value of Indian imports from Russia is $8.6 billion of which 30% would be hydrocarbons. Basically, Russian heavy crude does not have wide acceptance in Indian refineries. So the direct effect in terms of supply disruption due to Ukraine-Russia war for Indian refineries would be minimal. The impact will be through price escalation route, after all India imports around 80 to 85% of its oil requirements from abroad. An earlier RBI study tends to indicate that a $10 increase in crude price per barrel would raise inflation by 0.49%, if there is no pass through to the customer then fiscal deficit to GDP ratio would go up by 0.43%, which can be treated as the upper threshold. An increase in crude price would also increase the current account deficit to GDP ratio sharply, rise in GDP alone cannot nullify it. In other words, a shock through crude price increase would worsen macro stability measures like CAD (Current Account Deficit) to GDP ratio, fiscal deficit to GDP ratio and inflation. This is a likely scenario in the context of Ukraine war and policy makers need to take it into consideration.
Ukraine war will also affect the global agro commodity market adversely. Russia and Ukraine together account for 30% of world wheat export. Countries like Turkey, Egypt, Iran and several North African nations are largely dependent on this bread basket. War has suddenly increased the price of wheat and destabilised the supply chain. So far as edible oil is concerned, Ukraine and Russia are the main suppliers of sunflower oil to India. India imports about 2.2 to 2.5 million tons of sunflower oil every year. Around 70% of it comes from Ukraine, 20% from Russia and 10% from Argentina, etc. Should prices escalate sharply due to the war or the supply chain is affected, then the Indian consumer will have to switch over to other edible oils. Maintaining the supply chain is a key issue in war torn Ukraine, rail traffic has been affected badly, Black Sea ports like Odessa have become non-operational. On top of it short-term financing by large European Banks specialising in commodities has been stopped in view of sanctions.
Another area that is going to be affected by the Ukraine war and concomitant sanctions is metals. Both the countries are leading producers of nickel, aluminium, copper, palladium and platinum. Sanctions against Russia has already led to a 80% increase in palladium prices. Palladium is used in automotive exhaust systems, mobile phones, etc.
Neon is another item which comes from Ukraine. According to certain estimates 90% of semi conductor grade neon for US industry originate in Ukraine. The aerospace industry in western countries source a major part of their requirement of titanium from Russia. Given the context of sanctions it will be difficult to do so in future. What will happen to long term contracts, some extending up to 2028 remains to be seen. It was expected that the microchip shortage would be behind us by the end of 2022. In the view of the Ukraine war and sanctions, sourcing difficulties for neon, palladium and platinum which are used in microchip production would continue to bother the industry.
Sanctions against Russia, removal of selected Russian banks from SWIFT, freezing of Russian Bank’s assets in western countries would lead to a sharp fall in the value of Rouble vis-a-vis dollar and Euro. However, in areas where Russia has oligopolistic or near monopoly advantages like oil and gas (in Europe) nothing prevents it from raising prices. Once price is raised that could become the benchmark for global oil industry unless other countries in OPEC are made to raise production or sanctions against Iran are withdrawn. Secondly, these sanctions will increase Russia’s reliance on China. Even before the Ukraine conflict China and Russia have signed a thirty years gas supply deal using Yuan as the currency in use instead of dollar. China is already Russia’s biggest trading partner, 23% of Russian imports and 15% of its exports are with China. From the post Crimea sanction days Russia is steadily steering its economy closer to China, in fact it is a major recipient of Chinese loans. Further sanctions against Russia would bring Russia and China closer both in political and economic terms, this would not be a good geo-political development for India.
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.
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