Russia-Ukraine Conflict Impact To Be Treated As 'Supply Shock' For Monetary Policy Setting: RBI's Patra

Recent geopolitical risks emerging from the Russia-Ukraine conflict could pose upside risks to India's inflation forecast and may necessitate a review of growth forecasts, said Reserve Bank of India Deputy Governor Michael Patra in an address at the Indian Merchant‘s Chamber on Friday.

However, it is reasonable to treat the impact of the geopolitical crisis as a "supply shock" for the purpose of monetary policy, said Patra, suggesting that central bank may choose to look through any inflationary impact brought on as a consequence of the crisis.

For India, direct trade and finance exposures in the context of the ongoing conflict are limited, said Patra. "Contagion could, however, impact India through a broader fallout on emerging market economies as an asset class."

As such, the main transmission channel is likely to be global liquidity conditions, which are tightening, said Patra. "If worry were to give way to panic, liquidity, especially U.S. dollar funding, could dry up and markets could malfunction."

Meanwhile, crude oil above $100 per barrel could lead to new macroeconomic headwinds and act as a second channel of contagion. A third channel could be inflated country risk premiums, which raise the cost of funding for emerging economies and reduce investment volumes, said Patra.

Inflation And Monetary Policy Impact

Commenting on inflation, Patra said that international crude prices present an overwhelming risk to inflation. However, headroom exists to adjust excise duties, which, in turn, can delay the pass-through to pump prices, he said.

"On the other hand, prospects for the easing of food inflation remain bright with record production and buffer stocks," said Patra. Strong supply-side interventions and increase in domestic production can check inflation in sensitive items like pulses and edible oil prices. However, a spillover from the geopolitical situation cannot be ruled out, he added.

Patra, however, took comfort in the fact that while cost-push pressures on core inflation remain elevated, selling prices of businesses remain subdued due to low pass-through of given the large amount of slack in the economy.

The RBI and the Monetary Policy Committee have maintained a status quo on rates and held on its accommodative monetary policy stance despite inflation concerns. The regulator expects inflation to average 4.5% in FY23, an estimate that economists see as low.

Patra said the central bank would undertake a "thorough review" of its forecasts in April.

The deputy governor, however, added that India's inflation scenario currently is far better than it was in 2013, when the economy faced the brunt of the taper tantrum amid tightening from the U.S. Federal Reserve.

Headline inflation in India has remained in single digits and has tended to revert to the target as supply shocks have eased, said Patra. Also, while
global spillovers have kept core inflation high, there is an absence of second round effects in terms of higher wages and rentals, he said, adding that low pricing power has also tempered price pressures.

Downside Risks To Growth

While the Indian economy is recovering, GDP is expected to rise only 1.8% above pre-pandemic levels in the year 2021-22, said Patra. "Private consumption is just a shade above its pre-pandemic level, with discretionary consumption spending lacking traction. Private investment is yet to participate in the recovery."

However, the government’s thrust on capital expenditure in 2022-23 can be the game changer, said Patra, adding that this would be supported by conducive financial conditions maintained by the RBI and improving business and consumer confidence.

Another silver lining is export performance, he said.

External Sector Resilient

One source of strength for the Indian economy is the external sector.

The current account deficit is expected to remain within 2.5%, said Patra, adding that external financing is no longer a concern. "In fact, FDI alone fully finances the current account gap today."

The deputy governor added that forex reserves of over $600 billion are close to 20% of GDP and the import cover provided by them is double what it was in 2013. In addition, there are second lines of defence in the form of forward assets and swap lines, he said.

While India cannot be immune, a strong and resilient external sector can help cushion the economy from shocks, mitigate their impact and "provide headroom for monetary policy to pursue national objectives without being derailed by these tidal waves from abroad", Patra said.