Russia-Ukraine Crisis: Economists Flag Higher Inflation Risk, Wider Current Account Deficit For India

Russia’s attack on Ukraine and punishing sanctions in response could keep oil and gas prices elevated, posing a risk to India’s macroeconomic stability by way of a wider current account deficit and higher inflation, according to economists.

Brent crude prices surpassed the psychological $100-a-barrel mark for the first time since 2014 on Thursday. Prices hit an intraday high of $105.79 before a modest decline on Friday, but remained elevated.

A crude price shock poses a problem for the Indian economy. If oil prices remain high, it can cause retail inflation to spike and impact household budgets, unless balanced by union or state government tax cuts. It may also widen the current account deficit, because of a higher oil import bill.

Here’s what economists have to say:

Deutsche Bank

CPI Inflation

• A 10% increase in global oil prices raises CPI inflation by about 30 basis points.

• With global oil prices currently being 30% higher than RBI’s baseline estimate of $75 per barrel in October, a complete pass-through may increase upside risk to CPI inflation by 90 basis points.

• With central government excise duty cuts if oil prices were to sustain above $90 a barrel in the coming months, even a 50% pass-through of higher oil prices to consumers would mean 30-50 basis points upside risk to the baseline CPI estimate.

Current Account Deficit

• Elasticity of India's current account with respect to oil prices is estimated at about 0.40—that means a 10% rise in oil prices worsens current account by about 0.40% of GDP.

• If Brent stays elevated at current levels, then current account deficit could rise to $105 billion or close to 3% of GDP, turning the balance of payments to a negative even after assuming an optimistic capital account surplus of $95 billion in FY23.

Monetary Policy

• Given the RBI’s dovish bias, the central bank may very well perceive the current oil price increase as a bigger risk to growth, thereby delaying the normalisation process further.

Nomura

GDP Growth

• Every 10% increase in oil prices would shave off about 0.20 percentage points from GDP growth.

• “This could add to growth uncertainties, as India navigates an uneven recovery and counter near-term tailwinds like higher public capex, services normalisation and easy financial conditions, adding downside risks to the GDP growth projection of 7.8% year-on-year in FY23 from 8.7% in FY22,” Sonal Varma and Aurodeep Nandi, India economists at Nomura, said in a report.

Current Account Deficit

• A 10% rise in crude oil prices typically widens the current account by 0.3% of GDP. The current account deficit was projected at 2.6% of the GDP in FY23—up from 1.7% expected in FY22. It is now susceptible to widening.

Inflation

• A 10% rise in crude oil prices typically leads to a 0.3-0.4 percentage points rise in headline inflation.

“We maintain our outlook for 100 basis points of policy repo rate hikes in 2022, starting in June,” they said.

Fiscal Deficit

• The rise in crude oil and food prices could increase the government’s fertiliser and food subsidy expenditure. With a growing risk of the government cutting excise duties on petrol and diesel again, could lead to a higher fiscal deficit.

State Bank Of India

The decline in crude prices from the current high levels could come even faster going by the recent trends and it augurs positive for overall macro prognosis, said Soumya Kanti Ghosh, group chief economic adviser at State Bank of India. Financial markets also recover faster after a geopolitical-induced decline as past experience reveals.

Inflation

• The average price of Indian basket of crude oil has risen to $84.67 a barrel in January. If crude oil price rises to an average of $100 a barrel from the current average, inflation is likely to increase 52-65 basis points.

• Based on the existing VAT structure, diesel and petrol prices should have been higher by Rs 9-14 each as of now.

Public Finances

• If the government reduces the excise duty on petroleum products and prevent the prices of petrol and diesel from rising, then the government will incur excise duty loss of Rs 8,000 crore for a month.

• Assuming the reduced excise duty continues in the next fiscal and assuming petrol and diesel consumption grow 8-10% in FY23, the revenue loss of the government would be Rs 95,000 crore to Rs 1 lakh crore for FY23.

Trade

• Along with elevated oil prices, other commodities which will see inflation include precious metals gold, palladium and platinum.

• Ukraine being important exporter of agriculture products, there could be impact on prices of wheat and corn.