Just when we thought we had seen the end of the Coronavirus crisis, the last half of last month was hijacked by the escalating Russia-Ukraine conflict. This is obviously going to throw a spanner in the works for global recovery and economists will be furiously trying to recalibrate their growth projections for 2022 based on the unfolding events. Until the protagonists finish toying with the critical components, we cannot really make any accurate predictions about the immediate future. Let’s look at the components:
The most critical is energy availability and prices. Already in a bull run leading up to the end of last year and the beginning of this year oil and natural gas prices are facing an immense period of uncertainty. With major producers already kept out of the international markets- Venezuela and Iran, Russia is one of the major suppliers of oil to the global markets. Any disruption here would send oil prices up even further. Natural gas prices have also seen a rising trend since 2020 (where it touched a low of US$ 1.4 MM/btu) and- though off its highs at US$ 5.60 MM/btu (currently at US$ 4.4) it has the potential to spike again. The spike could arise because Russia supplies 1/3 of all of Europe’s natural gas needs to power homes and factories alike. Germany gets half of its energy needs met by Russia. If things start to go badly for Russia and they see European support for Ukraine as a cause they could start curtailing output to Europe in retaliation. The only possibilities of a turnaround in oil (or a fall to a lower equilibrium) are if Iran signs the treaty which limits their nuclear advancement but allows them to access the oil market with exports and also if Venezuela is allowed back in. It is unlikely that, without these external supplies coming onstream, OPEC+ would be incentivized to increase production to push prices lower.
This is particularly important as the ECB- holding out against rate hikes as long as possible in order to provide an accommodative atmosphere for growth, has cited rising energy prices as the main likely trigger for changing their stance. The US, already committed to a series of rate hikes to combat high inflation will- in the event of an oil price rise, see inflationary pressures build up even more. Although they are net energy neutral (producing their own requirements) the high prices will shift income from the consumers to the producers. With fiscal corrective measures becoming increasingly counter-productive (in a supply shock situation) and deficit financing likely to become prohibitively expensive we could see another bout of recessionary forces build up.
The immediate impact of the SWIFT ban on select Russian banks, sanctions on Russian oligarchs, restrictions on Russian use of airspace (and landing rights) etc will be a disruptive ripple across the economically interlinked globe. Though Europe has tried to limit the damage upon itself by excluding oil and gas payments from the SWIFT ban there is the question of stuck payments in the system as Russian payments and receipts are no longer allowed. This could cause defaults in the payments system globally and may require the US Federal Reserve to step in with some liquidity support. Furthermore, Russian owned assets in other countries (particularly Europe) could see some fire-sales as the wealthy liquidate them to try to keep these assets from any form of confiscation.
The possibility of escalation looks large. Ukraine is refusing to give up- the only way this could have defused quickly and Putin has his entire reputation staked on this and this could mark his end if it fails- which makes it doubly dangerous. Escalation will only force further European sanctions. Russia had built up a huge war-chest with US$ 630 billion in foreign exchange reserves but there may be sanctions on their access to a lot of it. And further down the road- if he succeeds, China may attempt the same thing with Taiwan. So, geopolitically there is much at stake for all sides.
The fluid global scenario makes analysis of the impact on India and the Rupee difficult. Higher energy prices (particularly oil) will create strong upward pressure on the US$ against the Rupee. Downstream, this added burden on the resources of the country will put downward pressure on GDP growth. Current revisions to growth expectations are already being made- downwards not unexpectedly. The government has lots of headroom to undercut the effect on inflation through reducing the taxes on fuel but no fiscal space to do so. So, there are serious constraints on the government being able to offset this imported inflationary pressure. In terms of the markets, the whiplashing movements are symptomatic of participants seeing every development as the start of a trend. This will create enough volatility to push longer-term investors to the sidelines- into a risk-off status, which is again a negative for Emerging Markets which are heavily dependant on foreign flows; India is a prime example.
The overall risk for the INR is therefore on the weaker side. We have already seen the trend begin before the commencement of hostilities and this is not going to reverse overnight. The war will not have a direct impact on Indian markets but the negative side-effects will be significant.
Technically, the USD-INR remains in an uptrend channel that began in May 2021 around 72.30 and which gives it a potential to reach 76.80 this month. Note that this is not a likely target but a technical possibility. Given the likely hypervigilance from the RBI to protect against any surges in volatility or to calm market panic, a more likely range would be 74.60 on the low side and 76.20 on the upside. Of course, given the volatile situation on the ground there could be openings first thing in the morning that are out of the range but we expect the broad range to hold. Unless there is a nuclear war of course…
Bonne Chance