The escalation in sanctions against Russia, including a price cap on oil and a possible cap on gas prices, means more trouble for the world economy and especially for the economies of Europe. On top of that, Ukraine has launched counter-offensives against Russia in the north and the south. The Russians cannot be expected to take that lying down.
So, the outlook for the world has worsened in recent days. But it doesn't look as though the world's leading stock markets have noticed. Do they know something that the world's leading agencies, including IMF and World Bank, have missed.
My article in BS today, Global outlook grows murkier after Russian setback
FINGER
ON THE PULSE
T T RAM MOHAN
Global economic outlook grows murkier after Russian setback
As
Ukraine escalation raises the risk to global economy, it is time to hunker
down for the rough ride ahead
“We are at war”, says French President Emmanuel Macron.” German Chancellor Olaf Scholz sounds only a little less sombre. “We live in serious times… but we are prepared”. After more than six months of relatively low-intensity warfare in Ukraine, there is the prospect now of a substantial escalation on both the economic and military fronts. That bodes ill for the world economy. India’s policymakers need to brace for a rougher ride than thought until recently.
Russia
has shut down the Nord Stream 1 gas pipeline that supplies gas to Europe. Last
year, the pipeline provided an estimated 35 per cent of Europe’s gas
imports from Russia. Russia says that Western sanctions against it make
it difficult to ensure effective maintenance of the pipeline. Nord Stream 2, which
was due to start supplying gas to Europe in early 2022, faces sanctions
from the US and the EU, which make it a punishable offense to utilise the
system.
Russia’s
decision to shut down the Nord Stream 1 pipeline came soon after the G-7
countries agreed to impose a cap on Russian oil prices. The G-7 intends to
apply the cap to all countries purchasing oil from Russia. How to enforce a
price cap in the case of non G-7 economies? The idea is to deny insurance and
finance to oil cargoes that are priced at above the price cap that the G-7 will
impose.
. The
EU is contemplating a cap on the price of gas imported from Russia as well. The
West contends that it has little alternative given the steep rise in gas
prices. Speaking at the East European Economic Forum earlier this month, Mr Putin
explained that the West had only itself to blame for the spiralling price of
gas.
Mr Putin
said that Russia had long tried to persuade the EU and other buyers to enter
into long-term contracts for gas— at one point, Russia was negotiating the
supply of gas at $100 per 1000 cubic metres. After the Ukraine conflict
erupted, Ukraine chose to shut down one of the two gas pipelines passing
through it. Poland sanctioned the pipeline passing through Poland. For these
and other reasons, gas prices have climbed to $3,000 per 1000 cubic
metres.
The
EU now thinks price caps on Russian gas are the answer. Mr Putin has
warned that price caps would amount to violation of contractual obligations and
Russia would not hesitate to cut off all energy supplies — gas, oil, coal and
fuel oil — if that happened.
As
though the escalation in the economic war was not bad enough, there has been a
change in the military situation on the ground. Until a few days ago, the
general sense was that the war of attrition of the past several months would
continue. The Ukrainian counter-offensive in the Kharkiv region in the north
and in the south has changed perceptions. Ukrainian claims about territory
regained need to be taken with the proverbial pinch of salt —the government in
Kyiv is known to make exaggerated claims in order to sustain the flow of arms
from the West.
Nevertheless,
it is clear that Russian forces have been dealt a blow in the north. This
has triggered nationalist outrage in Russia and scathing comment from sections
of the Russian media. Russia has responded by pounding the eastern region of
Ukraine with missiles, causing power blackouts in several parts.
Russia
has thus far contented itself with launching what it calls a “special military
operation”, intended mainly to protect lives in the two provinces in eastern
Ukraine that have declared independence. But increased Western military support
to Ukraine and setbacks on the ground for Russia have prompted calls for a radical
change in Russia’s approach. Mr Putin
is under pressure to deliver a knock-out blow by bringing the full might of
Russia to bear on Ukraine. Prospects of a negotiated peace have seem very
distant now.
These
developments render the global economic outlook murkier. The International
Monetary Fund (IMF) had projected global economic growth of 3.2
per cent for 2022, down from 6.1 per cent last year, and at 2.9 per cent in
2023. That was the baseline scenario.
The
IMF had also looked at an alternative scenario in which Russian oil exports
fall by 30 per cent relative to baseline, Russian gas exports fall to zero and
inflation expectations become more elevated. Global growth in that scenario
drops to 2.6 per cent in 2022 and 2 per cent in 2023. The EU would bear
the brunt of the shock with growth in the EU being near zero.
That
scenario, which would place global growth in the bottom 10 per cent of outcomes
since 1970, does not appear far-fetched now. The changed outlook will
increase uncertainty over the conduct of monetary policy in advanced economies
—to hike or not to hike policy rates will be a difficult call (except, perhaps,
in the US).
How
does India respond to increased uncertainty about global growth prospects? First, it is
unrealistic to expect exports to be a key driver of growth in today’s troubled environment.
The decision to walk on two legs — to push exports where possible and also
promote indigenous production through modest protection and subsidies — is an
experiment worth persisting with.
Secondly,
it is not advisable to allow the exchange rate to depreciate too steeply and
bear the full impact of the shock in the hope of benefiting from a rise in
exports. In a crisis such as the present one, the dollar is the default option
for investors. Net foreign institutional investor (FII) flows have
turned positive in July and August. Too steep a depreciation in the rupee with
respect to the dollar could lead to a swift reversal of this trend. The Reserve
Bank of India must continue with careful management of rupee
depreciation.
Thirdly,
embarking on “big bang reforms” at this point, as many urge, would be unwise.
We do not need political turmoil in the country to add to the grim global
outlook. We need instead to hunker down for the rough ride ahead.
