Russia-Ukraine Conflict: Impact on Indian Economy

We addressed the series of disputes between Ukraine and Russia in the first part of the article, which eventually led to the current geopolitical crisis. In the second part of the article, we’ll go through the current problem in details, as well as the impact it has on other countries, particularly India, and the modifications and steps that need to be taken to address it.

Current Situation  

Russia has launched a land, air, and sea invasion on Ukraine, which is by far the greatest conventional military invasion since World War II. Volodymyr Zelensky, Ukraine’s newly elected president, implemented the “Steinmeier Formula,” a peace proposal suggested by a former German president as an alternative to the Minsk agreement. According to this formula, Ukraine must declare the Donbas region autonomous status, but only after holding local elections, which must be done only after a complete peace and departure of Russian troops and weaponry. The results will be recognised by the Organization for Security and Co-operation in Europe (OSCE). Ukraine made such a demand because it intended to reclaim complete control of its eastern border before holding elections as required by Ukrainian legislation. In response to such demands, Russia insisted on elections and autonomy in the Donbas region. The risk that Ukraine faces if it accepts Russia’s terms is that pro-Russians will control huge political power while sustaining and developing the economy of an autonomous area. There were fears that, after granting autonomy, there might be internal turmoil or that it would aid Russia in influencing Ukrainian politics. All of this has culminated in the failure of the Steinmeier Formula.

Ukraine, which is now not in a position to wage a full-fledged war against Russia in order to reclaim its land, will need NATO’s assistance. Along with the aforementioned concerns, a special status for the Donbas region is not possible. It will enrage the Ukrainian people, who will perceive it as making concessions to Russia, maybe triggering another catastrophic crisis similar to the one in 2014. For many years, the Donbas region has been influenced by Russia and kept off from Ukrainian politics and media. As a result, altering the Russian narrative in order to conduct elections in this region may prove challenging for Ukrainian lawmakers. Both NATO and the United States had promised help to Ukraine, and in 2016, NATO decided to deploy military forces to eastern Poland and the Baltic in order to deter future Russian intervention in other regions of Europe.

Now the question arises: why has Ukraine not yet been admitted to NATO, despite the fact that these countries have pledged so much assistance? It is predicted that after Ukraine is granted membership, large-scale migration to other regions of Europe will occur in quest of greater economic possibilities and a higher quality of life. Within NATO, granting Ukraine membership is not widely supported — the US and EU are fully aware that Russia is already present in Ukraine. If Ukraine is granted NATO membership, intervening in the war in Ukraine and deploying troops as a NATO ally to confront, Russia would be the only course of action. The United States has recently exited Afghanistan, and sending troops to fight Russia would be dangerous. Russia has mentioned democratic elections, and NATO forces will not be able to invade Russia since it has demanded it. Hence, they are not in a hurry to give NATO membership because they are cognizant of the broader situation. Both Ukraine and Russia cannot agree to give the Donbas region autonomy due to fundamental differences in the conditions. The only way out here is for someone to relinquish their demands, which no one is willing to do at present. Many countries are now supporting Russia when it is portrayed as a Western vs Russian conflict. Russia is fully aware that as long as Ukraine retains NATO support, it will not relinquish control over the country. The West’s current priority is on neutralising such leverage. As previously said, Russia supplies natural gas to Europe, and the US has threatened to block the multibillion-dollar Nord Stream 2 gas pipeline project if Russia invades Ukraine. Europe is Russia’s largest natural gas market, and imposing sanctions will harm Russian exports. Before such sanctions are imposed, Europe must also identify an alternative to gas. As a result, Ukraine would suffer as well, as Ukraine supplies the majority of natural gas to Europe. Such threats of sanctions were causing panic in the Ukrainian financial sector, as rising tensions between Russia and Ukraine would result in price increases in Europe, as well as higher costs of expenditure for companies that rely on Russian gas. The European financial market will be affected as a result of all of this. As a result of the withdrawal of all foreign investors from the market, the market took a significant knock. If imposed, the sanction would have an impact not only on Europe but also on the world economy. Only the absence of US and EU interference on Ukraine is demanded by Russia. It demands written assurances that NATO will not expand eastward, troops will be removed from Poland and the Baltic nations, and US nuclear weapons will be removed from Europe. The most crucial of these assurances is that Ukraine will not join NATO.

Russia has paid a high price for the invasion, with interest rates having doubled, foreign investors pulling out of the stock market collapsing, and the ruble plunging to its lowest level. Because of the sanctions, Russians are unable to convert any money they have into foreign currency and are unable to purchase certain foreign brands. Rating agencies have forecast that if sanctions are imposed for an extended period of time, they will be unable to repay their creditors, making it difficult to attract foreign investment without substantial guarantees.

Russia-India Economic Relationship

In terms of bilateral trade and cultural exchanges, India and Russia have a long history of cooperation. Defence, information technology, pharmaceuticals, precious stones, agro-industries, energy, fertiliser, mineral and metallurgies, and other sectors are also involved in India-Russia economic relations. The countries’ trade relations have improved, and they intend to boost bilateral trade flows and investments in the coming years. To enhance bilateral commerce, both governments have established a specific economic plan based on numerous economic components. Russia’s participation in the “Make in India” project, as well as its involvement in the development of Smart Cities employing Russian technology, will be beneficial to India. Because the West has barred Russian banks from using the SWIFT messaging system (which allows international financial transactions), India and Russia have developed an alternative payment mechanism, an independent rupee-ruble exchange system. An Indian exporter will be paid in Indian Rupees rather than the standard international currency, the dollar or the Euro, under this exchange system because India buys various vital goods from Russia, such as sunflower oil, fertilisers exports, and petroleum products, an alternative payment system is necessary. India is also reliant on Russia for defence equipment and parts.

Ukraine-India Economic Relationship

Even when Ukraine was a republic within the Soviet Union, India and Ukraine enjoyed a strong and friendly connection. This long-standing friendship served as the foundation for flourishing trade relations and economic cooperation. In 1992, they signed a Treaty of Friendship and Cooperation, which improved their trade relations. Ukraine imports a variety of goods from India, including tea, coffee, spices, jute, silk, tobacco products, ores and minerals, pharmaceutical products, and pharmaceuticals. Ukraine exports a variety of goods, including machineries, engines, chemicals, equipment, plastics, iron and steel, and so on. Bilateral trade between the two countries has greatly improved during the last 25 years. India is Ukraine’s largest export destination in Asia-Pacific, and it has been shown to be economically beneficial. Ukrainian companies have long been active in the Indian industry, serving as a backbone in the country’s power and heavy industries. Trade links have resulted in increased scientific and technical cooperation between India and Ukraine.

Impact On Indian Economy

The Russia-Ukraine conflict has had a significant influence on the world economy, particularly in India, where the cost of living and raw material costs has risen dramatically. Conflict is the fundamental reason for the rise in energy prices, in addition to other factors. When oil costs rise, all forms of transportation, including land, air, and sea, rise as well. The overall cost of raw materials rises when transportation costs rise. Some oil corporations perceive the increase in price as an opportunity to increase profits or pay off obligations. Let’s pretend that company ‘A’ bought oil from Russia for $80 a barrel and stored it. Oil prices are currently high, averaging around $110 per barrel. Because Company ‘A’ is aware that oil prices may rise much higher, they are holding their stocks and waiting for a price increase. Let’s pretend there’s a shipping firm ‘B’ that needs oil to transport freight and is being requested to pay more than the present price by the oil company ‘A.’ The shipping company ends up buying at a price quoted by the oil company ‘A’, despite knowing all the costs and business to be taken care of, to be prompt, and to have significant export and import requests from countries. Increased price pressure will now be passed from the shipping company to individuals who want to convey their goods by ship. Let’s say you spend Rs.30,000 ($395) on a laptop in India. Due to rising transportation costs, the gadget firm in another country will export the goods to India and pay extra to the shipping company. As a result, the laptop’s price has been increased to Rs.35,000 ($460). The same thing can happen with raw resources like coal, minerals, iron ore, rubber, organic compounds, and so on. The sea route is the most convenient mode of delivery for bulk products, and cargo ships are used. The amount of diesel fuel consumed by these ships is enormous. Given that diesel and gasoline are refined from crude oil, rising prices are expected to affect the cost of goods linked to them. End-users bear the brunt of these price hikes. The imported raw materials are eventually extracted by several specific firms, which require large machineries and fuel. As a result, the Extraction Cost increases as well; subsequently, the overall import costs rise, which means the price of finished items, which are made up of raw materials, rises as well. Because of the steady rise in commodity prices, workers in these industries, who are also consumers, want a raise in pay. In India, the price of fuel has already surpassed Rs. 100 this year, and as a result of the dispute, the price is rising virtually daily. Last year, the federal and state governments reduced tax (VAT) to lessen the burden on consumers, and if the government wants to reduce taxes again this year, it will have an impact on government finances. Furthermore, such tax cuts will have an impact on economic growth.

India imports $832 million worth of precious stones and metals, $2.05 billion worth of oil and minerals, and $600 million worth of fertilisers from Russia, and the trade is likely to come to a halt as a result of Russian sanctions. However, this condition may assist domestic producers and competitors. Pharmacies are imported from India, and pharmaceutical companies have offices in Ukraine. Sales are likely to be hampered by the ongoing turmoil. Sunflower oil is imported from Ukraine at a rate of 70% in India, with a total volume of 2-3 lakh tonnes. As a result of the conflict, prices have risen, which will ultimately be passed on to Indian consumers.

Russia has been India’s technological and military supplier, and the sanctions imposed on Russia may have influenced on the import of Russian defence equipment. Russia may delay deliveries due to current tensions with Ukraine since they are preoccupied with providing their own soldiers. India receives spare weapons and gas turbine engines from Ukraine for numerous ships in the Indian navy. The degree of damage to military infrastructure has yet to be determined as a result of the recent fighting, although production lines for such supplies have been disrupted.

In the year 2022, it was expected that people would be more willing to participate in services that they had been unable to participate in owing to the pandemic. Consumers will shift from products to services, such as retail and recreation, travel, movies, and so on, with the price of services expected to rise. In the next years, small firms in the service sector may be able to take advantage of relatively inelastic demand (for example, people who have not visited restaurants or movie theatres since the pandemic will be less price sensitive now when using these services). These businesses are likely to take advantage of the situation by raising rates because customers are willing to pay for the services. As a result, the entire scenario Prior to the conflict, it was expected that as the service sector opened up, service inflation would rise while products inflation would fall. This year was predicted to be a year in which supply chains would be stabilised, resulting in lower commodity prices. The concern currently is that services inflation will emerge as a result of the conflict; nevertheless, because energy costs are high and supply chains may be interrupted; there is a cost push on enterprises, which may pass these pressures on to consumers in the near future. On the one hand, the economy is growing more slowly, while inflation is rising rapidly.

Bond yields will range from 7% to 7.4%, increasing the government’s borrowing costs for fiscal deficit monetisation. India’s current account deficit (CAD) grew in the third quarter of 2021-22, owing primarily to a trade deficit (the country’s cost of imports has increased the value of exports). With trade deficits growing and capital inflows stagnating, the Balance of Payments might face major strains. Although the RBI can alleviate the pressure by using $68 billion in Spot Forex Reserves and Forward Book, but there are several complications. When the economy is affected by negative trade shocks, the currency will depreciate in value. Exporters will be exposed to exchange rate concerns if the Rupee continues to depreciate.

Keeping aside the complications, there is a tinge of optimism in the air. Both Russia and Ukraine are large grain producers, and India can fill the void caused by the conflict by exporting wheat to other countries. It is projected that India will produce a record crop of grains, providing an opportunity for the country to stay on the up and up.

Way Forward

In the future, India should endeavour to hedge its oil costs. India is a major importer of crude oil. It should endeavour to shield itself from price fluctuations. India should try to hedge its oil costs in the future. India is a big crude oil importer. It should make every effort to protect itself from the erratic nature of oil prices. It should establish an institutional framework to gradually hedge such oil prices in global financial markets so that it does not find itself in a situation where oil prices have climbed from $80 to $120 per barrel. It should set up an institutional framework to gradually hedge such oil prices in global financial markets so that it does not end up in a situation where oil prices have risen from $80 to $120 a barrel.

Negative trade shocks will cause currency depreciation, which some experts believe is the best reaction because allowing the currency to adjust on its own will force the necessary expenditure switching. Encouraging the currency to find its equilibrium on its own will make imports more expensive, resulting in a boost in exports and a steady narrowing of the trade deficit gap. Since the RBI is cautious, orderly modifications should be considered healthy in order to avoid any unexpected fluctuations. Interfering with the adjustment process is not encouraged, but reserves could be employed to ensure a gradual and measured return to equilibrium. It is necessary to enable the adjustments because they may act as a shock absorber for the economy when it is affected by negative trade.

When there is fiscal pressure — price hikes, subsidy hikes, or excise reductions – Capital Expenditure is the first to suffer. A slight buffer had been provided by the current Budget and initiatives. Even if the fiscals take a blow, the budgetary expenditures will not be cut. If the oil shocks had not occurred and revenue had increased, there would have been greater resources available for investment in Capital Expenditures. Due to the revenue buffer provided in the current scenario, providing at least some of what is budgeted will almost certainly be possible.

Disinvestment strategies that are institutionalised and systematic are urgently needed. Even though markets are currently highly volatile, the government must proceed after they have calmed. These are the resources available to the government for capital expenditures or fiscal consolidation. During the Great Depression of the 1930s, British economist John Maynard Keynes proposed the hypothesis that during times of economic distress, government expenditure should be increased to compensate for falling investment and to boost consumer spending so that aggregate demand could be stabilised. According to analysts, this notion is critical for India to overcome the wrath of the economic crisis brought on by the conflict, just as it was attempting to recover from the pandemic.

After the pandemic, most of the emerging economies are still below the pre-pandemic path to different degrees. The income loss during the pandemic becomes more severe the longer the economy remains there. Private consumption and expenditure must step up the pace in the coming years if growth is to be sustained which is expected to occur soon.

According to the GDP formula C+I+G+(X-M), consumption (C) is unlikely to expand until India’s employment situation improves. In recent years, we’ve observed a slowdown in private consumption. The current problem is one of supply. Manufacturing’s utilisation rate is still not high enough. Even though businesses are ready and prepared to spend, transparency on demand neutralisation is required. Consumption and investment have yet to rebound, and government spending and net exports will have to work harder in the foreseeable future.

The government’s push for public infrastructure is the right one because infrastructure projects create a lot of construction jobs, which leads to a rise in consumption. If there is a governmental investment, it is hoped that private investment will follow. Fiscal policy, rather than monetary policy, is better adapted to providing targeted support.

Conclusion

This year may prove to be more difficult than predicted, and the expectations on which the budget was based could result in a different outcome. It was expected that after the situation had stabilised following the pandemic, there would be increased growth and lower inflation rates. However, the Indian economy’s growth rate may slow as a result of the conflict, and inflation is already rising. There will be many more individuals who will want assistance; thus, targeted assistance (offering free food grains, creating jobs) should be prioritised. In addition, the government borrowing may be higher, for which RBI will have to do its debt management. Proper transparent dialogues among policymakers are urgently needed to ensure that stabilisation efforts are coordinated and that the outcomes are not as terrible as feared. A country’s attention should be on establishing both internal and external balance at the same time. It would be difficult for any emerging market to attain. For the time being, analysts advise that the Rupee be used to adjust the external balance, while the government should concentrate on fiscal policy to maintain the internal balance. The conflict’s unpredictability is not limited to Russia and Ukraine in today’s interconnected world; it has repercussions for other economies as well. Leaders from around the world should meet and devise a plan to end the problem. Such a geopolitical issue, which results in sanctions, causes suffering not only to one country but also to the dependent country. Let us all hope that when the situation improves, people’s lives will become more stable.

 Reference

1. Magazine Aanchal, (February 24, 2022), India’s inflation concerns over Russia-Ukraine war. Indian Express
2. Patel Mira, (March 05, 2022), What Russia means to Ukraine: A long complicated history. Indian Express
3. Kirby Paul, Why has Russia invaded Ukraine and what does Putin want? BBC News
4. Verma Mimansa, (March 15, 2022), How will the Russia-Ukraine war impact the Indian economy? Quartz
5. Bhalla Abhishek, (March 07, 2022), Will Russia-Ukraine war impact India’s defence imports? Delivery of orders worth $9 billion still pending. India Today
6. Srinivas Srikanth, (April 03, 2022), Russia-Ukraine War: What Impact Can It Have on India’s Economy? In

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