Thinkpad: Trouble Comes In Threes

Thinkpad: The Russia-Ukraine conflict forces a think of economic implications. For the world and for India.

Thinkpad: Trouble Comes In Threes

This week was all about conflict.

A conflict that has been feared for some time became a reality as Russia attacked Ukraine. Events are unfolding rapidly as we go into the weekend, with Russian forces moving deeper into Ukrainian territory and western nations pushing ahead with sanctions against Russia. You can track the global developments here.

Predictably, as the attacks began, oil prices soared and equity and currency markets fell.

Brent crude oil moved past the $100 per barrel mark for the first time since 2014. The higher oil prices could not have come at a worse time with global economies worrying about inflation even before pandemic induced uncertainties go away fully. Higher oil could add to inflation shock and dent growth. For a broader view on the global economic implications of the conflict, read here.

Oil prices eased a touch after the surge as initial sanctions did not directly target the oil trade. This piece explains why. Instead, sanctions focused on the financial sector and, notably, on technology, with the U.S. cutting off Russia from semiconductors and advanced technology. The U.S. is giving Russia the same treatment it gave China Huawei, on steroids, writes Reuters in this piece.

Within the financial sector, two of Russia’s largest banks have been effectively barred from processing and settling payments within the U.S. financial system, Reuters reported.

There have also been calls to cut Russia out of the SWIFT network, a secure messaging system used widely for international financial transactions. The weaponisation of SWIFT has been contemplated in the past but if used in the case of Russia, it could set a precedent. So far, this option has only been used against North Korea, whose involvement in the global financial system is far smaller. It could also prompt countries to start working on alternatives to reduce its influence. You can read all about the SWIFT sanctions alternative here.

As an aside, you'll hear cryptocurrency circles buzzing about how this is just one more reason to break away from sovereign backed currencies and payment systems. *Eye Roll*

The Indian markets followed global markets lower. The NSE Nifty lost 3.6% even after the Friday rebound. The rupee, which fell 1.5% on Thursday, also rebounded by the close of the week.

If crude remains at close to $90-100 per barrel, India faces the prospect of higher inflation and a wider account deficit, said economists. Of course, India is far better placed to deal with an oil shock today than it was when prices were last at these levels.

Besides, there are some buffers available. The government can shield consumers by cutting fuel taxes to prevent a spike in inflation or incremental weakness in consumer spending. And the Reserve Bank of India has nearly $680 billion in forex reserves (including forwards) to work with to protect the rupee.

Indranil Sengupta of CLSA estimates the RBI has $80 billion to spare with $600 billion as an adequate level. Anyone complaining about the Indian central bank holding excess reserves now? We think not. RBI may not even have to spend this amount. As Sengupta said, when you have a big stick, just the threat to use it is enough. Over the last few years, in baby steps, the RBI has also gained greater ability to intervene in the offshore non-deliverable forwards market, which often leads currency volatility in times of stress.

But there is no denying that economic outlook is looking cloudier at the end of this week than it did at the beginning. Global monetary policy tightening is around the corner with India intending to break away and delay normalisation, oil prices could stay elevated for longer and some volatility may return to the country's external accounts. Trouble, as they say, comes in threes.

Till next week.

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