Soldiering on ukraine war’s economic fallout on india may not be severe fiscal policy must lead now

Soldiering on ukraine war’s economic fallout on india may not be severe fiscal policy must lead now

Russia’s Ukraine invasion will soon enter its third month. It has gone on longer than initially expected and appears likely to continue. The ray of hope is the now unlikely scenario of more countries being drawn into the conflict. The world, however, has not been spared the economic fallout of war. It’s working its way into the global economy through three channels. It’s pushed up fuel prices. Separately, other commodity prices and logistics costs have escalated. Finally, the uncertainty caused by war is weakening global demand.

The three channels are not pushing in the same direction. Weak demand partially offsets the fuel/commodity price pressure. The impact on India, therefore, is unlikely to be as severe as it appeared six weeks ago. This is because elevated inflation was the primary challenge India faced at the start of the war. Core inflation, excluding food and fuel, has been both sticky and higher than the pre-Covid period. In this backdrop, the war’s impact on crude posed a big challenge. RBI now expects crude price to average $100 a barrel, which is a little over 30% of the Budget’s assumption. The recent price trend suggests RBI’s revised assumption is well founded.

Food price build-up in 2022-23 came largely through vegetables and edible oil. Following the forecast of a normal monsoon and given India’s self-sufficiency in both cereals and vegetables, it is edible oil prices that remain vulnerable to global forces. In all, retail inflation is likely to hover around 6%, RBI’s upper limit of tolerance. The related question is, how will this impact growth as now interest rates are sure to harden? This month, the RBI forecast that economic growth in FY23 will be 7.2%, lower than what was expected before the war. The central bank simultaneously signalled a tighter monetary policy.

Global uncertainty poses downside risks to growth. Therefore, fiscal policy has to take over the primary role of boosting growth. In this context, India is not badly placed. Inflation has provided a boost to tax revenues. In FY22, GoI’s tax revenue overshot the Budget target to just exceed Rs 27 lakh crore. Importantly, it grew about twice as fast as nominal GDP and was 11.7% of GDP, a two-decade high. GoI has the space to first slash fuel taxes to cushion the economically vulnerable and push ahead with its infrastructure spending. It’s fiscal policy’s turn to do the heavy lifting and draw in private investment.