The Economic Impact of the Russia-Ukraine Conflict

The Russia-Ukraine crisis poses a challenge, but the equity asset market is resilient

The Russia-Ukraine crisis has sparked an upward spiral in commodity and oil prices. Global authorities have imposed stringent sanctions on Russia, which will put additional pressure on global supply chains. Hence, pressure on global and domestic inflation is expected to rise.

Russia’s absence in the global commodity market will be felt over the coming quarters. It is one of the biggest commodity exporters globally with a significant export base in metals and oil and gas markets. Russia exports commodities like aluminium, nickel, steel, and other commodities. Replacing the global supply chains and finding alternatives to Russian supplies could take a long time to replace.

Disruption spikes inflation

In this scenario, prices of metals and other commodities could remain elevated in the coming months. Russia and Ukraine are major producers and exporters of Agri-commodities such as wheat and oil, which will have an impact on food prices in the coming months.

Already, the global economy has been reeling under rising inflation for some time with covid-19 playing truant with supply chains for some time. The US economy has been hit hard with inflation in the past few months which has risen to a 40-year high. For some time, the US Fed had been dismissing the inflation pressures as transitory, but inflation is now hitting the roof. With global commodity and agri-prices shooting through the roof, inflation-control will be the main focus of central bank activity in the coming year.

The US Fed’s upcoming policy meet will clear the fog on whether the US will bite the bullet of inflation control or wait for the markets to settle down. Before the Russia-Ukraine crisis, the market had factored in a high probability of the US Fed raising interest rates. If the US Fed does indeed hike rates in the upcoming policy, foreign investors will continue to be underweight on emerging markets, which could put added pressure on the Indian markets.

Double whammy

The Indian economy could face the double whammy of rising commodity prices and higher global interest rates. These are seen as a stumbling block for demand growth as well, which could pose a major challenge to the economy in the near term.

Further, India will also have to foot the bill of the oil price hike. Much of that will be passed on to consumers through higher prices of goods and services. India imports about 85 per cent of its oil requirements, while the rest is met in-house. In case, oil prices remain at elevated levels, the Indian economy is looking at a scenario of high inflation along with higher current account deficits, which will also result in higher bond yields.

Already, the signs are showing. CPI inflation has increased to 6.1% in February from 6% last month, and 5% a year ago. Food inflation has increased to 5.9% from 5.4% in January. The pressures on inflation will be even more striking in the coming quarters. Crude oil prices have risen nearly $20-25/bbl in the fourth quarter, but the full pass through to retail pumps has been muted.

If the oil prices remain elevated in FY23, retail inflation could rise higher than RBI’s estimates. It is estimated that a $10/bbl increase in Brent crude price impacts retail inflation by about 30-40 basis points. Hence, much will depend on where oil price settles down or it could hit the nascent post-covid recovery of the Indian economy.

Every dark cloud has a silver lining. Ukraine & Russia are among the world’s largest exporters of wheat. The war has sent global wheat prices soaring. This gives India a golden chance to export record quantities of wheat. Several years ago, India exported a few million tonnes per year. This fell to zero when Indian wheat prices became higher than global prices. But in the current year rising world prices have made Indian wheat viable so exports can shoot up. If India can get a average price of $400 per tonne that will mean a whopping $ 8 billion for 20 million tonnes of export. Massive Indian wheat exports will not merely fetch a forex bonanza. They will also facilitate a sharp reduction of government’s bloated food stocks. These have been rising for years, since procurement has exceeded offtake from the Public Distribution System [PDS] and exports of wheat have been un economic for quite some time.

Strong backing by domestic investors

There are several pockets of resilience in the Indian market, given that the frontline indices have high exposure to sectors that will benefit from the rising commodity prices. Some of these sectors are metals, oil and gas, and export sectors such as IT and pharma that stand to gain from a strengthening dollar.  Sectors that could be hit would be domestic consumption, autos, FMCG, paint companies that tend to face higher input costs thus impacting margins.

Domestic investors are standing like a fortress. After an initial knee-jerk reaction, the Indian market has shown remarkable resilience in the last few days. Domestic investors have stepped up their investments. Foreign investors have remained net sellers in India in the last few months due to the risk-off sentiment. Since October ’21, foreign investors have pulled out more than $14 billion from the Indian markets.

On the other hand, domestic investors have more than offset the heavy FII selling by purchasing stocks worth more than $16 billion since October ‘21. Equity mutual funds have seen a net inflow of about ₹ 15000 crore in January or nearly 2 billion. This well-illustrates the fact that domestic investors have come of age and see the corrections as opportunities to invest.

So, on an optimistic note, even while the short-term sentiment is disrupted, domestic investors are keeping the faith and betting even bigger on the long-term resilience of the Indian economy and markets.

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