Ukraine war to worsen India's economic fundamentals

On March 24, 2022, the UN Conference on Trade and Development (UNCTAD) released its "Tapering in a Time of Conflict" report to say the global output growth is likely to go down from the earlier estimate of 3.6% to 2.6% in 2022 (January-December) – a 1% fall. To a great deal this would be due to the Russia-Ukraine war but also due to the pandemic pangs – asymmetric and short-term recovery, rising commodity prices and high global inflation.

For India, it said the fall in output growth (GDP) will be greater – from 6.7% to 4.6%. This fall is more than double the global average. Why so? It explained: "India in particular will face restraints on several fronts: energy access and prices, primary commodity bottlenecks, reflexes from trade sanctions, food inflation, tightening policies and financial instability."

There is little to doubt its assessments for two reasons: (i) recall how India's output growth fell by more than double (-6.6%) the global average (-3.1%) in 2020 (FY21 for India) when the pandemic hit and (ii) repeat of proven policy mistakes detailed in subsequent paragraphs.

War may impact GDP more than what CPI indicates

The UNCTAD report needs to be read in some detail because not much attention has been paid to the diagnosis and prescriptions.

On what it said about India, the tell-tale signs are visible on the ground.

Fuel prices have started going up again, after a four-month hiatus, for state elections, even as crude prices went up significantly (absurd as it may sound since fuel prices were fully decontrolled and market-linked in 2017). Oil companies, primarily public sector entities, are reported to have lost about $2.25 billion in these four months.

There is no sign of cut in oil tax, which remains elevated since 2015 when the crude price was half of what it is today – from over $100/barrel before FY15 (in FY12, FY13 and FY14), the crude price fell to annual average of $58.5 during FY15-FY21. During this time, the Centre kept raising taxes on fuel – excise, customs, IGST, CGST, service tax, cess, royalty, surcharge and others. The total oil tax collection jumped from ₹1.26 lakh crore in FY15 to ₹4.2 lakh crore in FY21 (and ₹1.98 lakh crore in H1 of FY22). That is, the Centre collected ₹20.7 lakh crore from oil taxes during FY15 to H1 of FY22 – when crude oil was half the cost.

The inflation is likely to remain elevated in near future, until fuel tax is cut, the war abates and fuel supply from Russia and other countries (Iran, the UAE, Saudi Arabia) compensates the price difference. International commodity prices were going up before the war and the war-induced disruptions in supply chains have aggravated it, impacting both India's exports and imports.

The cumulative impact of all these would mean the domestic inflation would remain elevated, above the current level of 6%, for some time. Now, this 6% inflation in Consumer Price Index (CPI) is a gross underestimate and misleading when it comes to estimating the economic (GDP) growth.

Here is why.

Look at the National Accounts Statistics. In its second advanced estimates (AE2), released on February 28, 2022, said the 'real' GDP growth for FY22 is likely 8.9% (already down from 9.2% in AE1, released on January 7, 2022). But the 'nominal' GDP growth for the fiscal is likely 19.4% (up from 17.6% in AE1).

What is the difference between real and nominal GDP?

It is inflation.

Now, for different components of the GDP different inflation indices (called deflators) are used, in addition to the CPI (also a deflator). So, what is the 'real' inflation in the GDP calculations for FY22? It is the difference between the real and nominal GDP growth, which is, 19.4% minus 8.9% – 10.5. The inflation indexing is not at 6% of the CPI but 10.5% of the GDP!

What it means is that even if the CPI inflation hovers around 6-7%, don't get lulled into thinking that the impact on the economic (GDP) growth will be just 6%. It would be near double (10.5% as per AE2).

But rising inflation is just one element. There are others.

Bad economics to worsen the war impact

As mentioned earlier, the UNCTAD report has already lowered global output.

It issued a warning too: "The year 2022 already appeared to be one of decelerating and uneven growth. The unprecedented policy measures that helped economies around the world recover from the paralysis of the Covid-19 pandemic have been asymmetric in their effects and short-term in scope, adding new challenges to an already testing policy environment.

"As we argued in September 2021 (TDR 2021), a return to pre-2020 conditions should not be the goal of policymakers. It would diminish the hope of achieving more inclusive and sustained growth and undermine the task of building economic resilience in the era of climate change. The threat of repeating the policy mistakes of the past is, however, rising as the fallout from the conflict in Ukraine spreads beyond its borders."

What do these paragraphs mean?

One, most economies adopted wrong strategies to come out of the pandemic crisis – stimulus and liquidity aimed more at industry through cheap bank credits (which has landed India in a liquidity trap since April 2020) while consumption demand had collapsed. This led to stock market booms and a surge in billionaires' wealth while millions were losing their lives and livelihoods. Such policies and strategies, by and large, made the recovery asymmetric and "short-term".

Two, it warns against returning to the pre-2020 policy paradigm that hurt inclusive and sustained growth, and endangered economic resilience by damaging the environment. The UNCTAD noticed that the same tendencies continued in response to the pandemic. Again, it noticed the same tendencies are "rising" again in response to the war.

It says, don't do that as they have hurt the economies and the people world over.

The IMF's inhouse magazine of March 2022 has rubbished one of such tendencies (economic policy) which IMF has actively promoted and forcibly imposed on nations seeking its loan since 1980s. It called for a rethink on – limiting debt-to-GDP at 60% and fiscal deficit at 3% – because of dramatic shift in ground realities in pre-pandemic period and also the pandemic experience. Fortune India's "Beware! IMF's rethink on debt-to-GDP, fiscal deficit limits, has consequences" detailed about this rethinking earlier.

In the Indian context, Fortune India's article, "Budget 2022: Address K-shaped distortions—recovery can follow" explains how those very policies (flagged by UNCTAD and IMF) led to the K-shaped recovery and warned against its short and long-term consequences for the people and the economy. There is yet another area of concern.

Risks to both exports and imports

The same UNCTAD report points to the threats of Ukraine war to developing economies like India.

It says: "The danger for many developing countries that are heavily reliant on food and fuel imports is more profound, higher prices threaten livelihoods, discourage investment and raise the spectre of widening trade deficits. With elevated debt levels from the pandemic, sudden currency depreciation can quickly make debt service unsustainable and tip some countries into a downward spiral of insolvency, recession and arrested development. Whether this leads to unrest or not, a profound social malaise is already spreading."

The big point here is adverse impact on international trade – burgeoning trade deficit, currency depreciation etc. – leading to economic slowdown. India’s net export (exports minus import) has been negative for almost every year in India's post-independent history. On the face of it, the war would turn it even more volatile and unpredictable.

Here it is important to draw attention to India's historic achievement of $400 billion in exports in March 2022. This needs to be seen in perspective to understand its importance for both short term and long-term growth.

India achieved this target particularly because of growth in electronics and machinery exports and rising commodity prices (gold and oil in particular). The war, if prolonged, presents a big threat to that. Export of mainly tea, pharma, leather and textiles to Russia and imports of electronic and electrical items, drugs and pharmaceutical formulations and much more from China (hit by fresh pandemic lockdown) would be hurt for the time. Since most of India's fertilizer and its raw materials are imported, this too would become scarce and costlier just ahead of next cropping season (impacting agricultural growth and raising food inflation subsequently).

Finding quick alternatives to all these exports and imports, which India is trying, is tough and time consuming. Until then, imports and exports will be hit – damaging the growth. In short, apart from fuel, food, FMCG products and white goods would be costlier, reducing consumption demand, which in turn will reduce production of goods and services, which in turn make fresh investments redundant – thereby slowing the future growth too.

Here is a sobering fact for those gung-ho about India achieving $400 billion export target.

The real measure of exports, imports and trade deficits is not in the absolute numbers – which keeps varying with inflation, among other factors. It is the growth in relation to the GDP that is the true reflection of their growth.

How does India perform on this parameter?

India's exports have actually fallen drastically from a high of 25% of the GDP for three consecutive years of FY12, FY13 and FY14 to an estimated 21% for FY22 (AE2) – when the exports have already touched $400 billion. The fall is a massive 4 percentage points.

Imports have fallen more sharply.

From the peak of 31% in FY12 to an estimated 25% in FY22 (AE2), it is a fall of 6 percentage points. Imports are important for exports too, as inputs for export goods, which economists call "import intensity of exports". India's import intensity of exports has risen sharply in post-1991 free trade era. Unless exports (and imports in sync) rise one of the key growth engines is disabled.

Trade deficits though have reduced from -6.5% in FY12 to -4.2% in FY22 (AE2). But this matters particularly when a country is going through foreign exchange crisis and unsustainably high current account deficits (CAD) – which are not the case with India now.

One of the key reasons for the dramatic fall in exports and imports (which are linked, as explained above) is two regressive elements of "AatmaNirbhar" philosophy (not the scheme by the same name):

• High import barriers to cut down imports and protect domestic industries from outside competition – the failed policies of 1960s and 1970s. This reduces imports, thereby hurting exports, and potentially turns Indian products globally uncompetitive. Neither boosts future growth.

• India's decision to keep out the big regional trade agreement, Regional Comprehensive Economic Partnership (RCEP), involving 30% of the global GDP will hurt its trade-induced growth prospects.

India is yet to abandon these policies. Recall the UNCTAD's warning against repeating past mistakes in response to the Ukraine war.

Continuation of regressive taxation

In the present context, there is yet another policy that would hurt India more.

The oil taxes have started rising virtually daily, which Fortune India had demonstrated earlier ("Why high GST collection is bad taxation and bad economics") that it hurts the poor and the economy – as 63.7% petrol used by two- and three-wheelers, against 34% by cars; 31% diesel by farmers and 70% by transport, both raising food and transport costs.

On March 27, 2022, US President Biden proposed a minimum 20% tax on US households worth more than $100 million, called "Billionaire Minimum Income Tax", in his budget, to mop up $360 billion in new revenue over 10 years to be used for fiscal spending (including massive social security cover they provide).

India does the contrary. Consider four facts:

• In 2019, India reported 140 dollar-billionaires and 7,64,000 dollar-millionaires. This is double the number of Indians, or 3,16,000, who actually reported income of above ₹50 lakh (in 2019) – demonstrating massive tax evasions and avoidance, and even tax fraud.

• India cut down corporate tax in 2019 by ₹1.45 lakh crore in the time of fiscal constraints promising higher investment and job creation. The same year the Centre refused to pay the GST Compensation to states the same month in violation of the GST law of 2017).

• On March 25, 2022, Finance Minister Nirmala Sitharaman said (two days before Biden's 20% tax on the super wealthy) she supported corporate corporation tax cut (of 2019) on the ground that it helped the economy, government and companies. This is contrary to evidence. The RBI wrote the tax cut was "utilized in debt servicing, build-up of cash balances and other current assets rather than restarting the capex cycle".

• In 2016, the Centre abolished wealth tax.

There is no change in the Centre's stand on any of it after the war threatens to derail the economic recovery.

Instead, Sitharaman blamed the Russia-Ukraine war for the rising fuel cost, shifting the entire burden on the poor.

Further, from April 2022, her government has allowed private drug companies to raise the cost of 850 essential drugs. Cheaper essential drugs help the poor. Raising the price raises profits of private drug companies – the same perverse economic philosophy that cut corporate tax down.

In the meanwhile, the RBI continues its cheap credit policy (repo rate unchanged since May 2020) to boost industries (in so far as credit outflow to industry remains poor, besides creating a liquidity trap) – something the UNCTAD and even two RBI reports of 2021 had warned against.

In essence then, if the war and the fresh outbreak of the pandemic in China don't end soon, the already fragile Indian economy would be even more so. And many more Indians will slip into poverty and starvation with the entire burden of inflation and business disruptions passing on to them.

Here is a word of caution.

It would be overoptimistic to assume that the hardening of ideological divisions that the war has brought about is going to disappear in a hurry. With Russia and China on one side and the US, EU, Ukraine and others on the other, India should prepare to recalibrate its foreign and trade policies.