Ukraine will upend Sitharaman’s dream budget

Far from condemning Russia for invading Ukraine, some Indians admire it. One person asked me: “Why can’t we be like Russia and invade Pakistan-occupied Kashmir?” He saw nothing immoral in it.

An amoral answer is that India lacks Russia’s immense military superiority. Unlike Russia, India faces a nuclear-armed foe backed by a superpower (China), whereas non-nuclear Ukraine has no guarantors (NATO will not fight for it).

Besides, can anyone want India to become an international pariah like Russia? Or to have the Indian government and financial system sanctioned? Russia is a major supplier of oil and gas to the West and so has considerable leverage. India has none.

Above all, India is very poor compared with Russia and cannot withstand global economic sanctions the way Russia seems prepared to. The Russian stock market crashed 50% and its currency dropped 20% on invasion day. Can anyone wish India a similar fate?

India is going to suffer severe damage anyway. How much? Nobody knows how long or short, deep or shallow the Ukrainian crisis will be. On invasion day, many expected the worst. But the next day Russia talked of negotiating a ceasefire with Ukraine, so markets rebounded. Right now, we can only project scenarios. 

Scenario One is a quick resolution of the crisis, with Ukraine and Russia striking a deal quickly. Western sanctions may continue for some time but will be eased. The world will not return to a pre-invasion norm – tensions will continue, and global investors will see emerging markets like India as risky.

Countries will reassess ties with Russia. Europe will seek to reduce energy dependence on Moscow and globally security will often trump commercial considerations. This will affect global GDP, investment and trade, but not severely. Alas, the chances of such a happy ending are close to zero.

Scenario Two is a crisis lasting months, maybe moving towards a muddled conclusion in late 2022. Fighting will continue with the West sending arms but no troops to Ukraine. Sanctions will deepen but only gradually, with the West keeping some trump cards up its sleeve. The price of oil and gas will spike for months before declining. Inflation will rise globally even as trade and GDP are mauled. This will be war-induced stagflation.

Scenario Three is an ugly, deep war with high casualties and unwillingness to compromise on both sides. Sanctions will go deeper and deeper. Although this will hurt the western power too, they will tolerate it to hurt Russia even more. GDP and trade across the world will be hit, and emerging markets like India will be drubbed. Inflation will soar as the West seeks to wreck the Russian economy and squeeze its oil and gas exports.

The end of the Cold War brought a peace dividend through reduced defence spending and soaring global trade and investment. In Scenarios Two and Three, the world will shift to a new Coldish War that reduces the old peace dividend. The effects will be long-term and adverse. 

India will be hurt in all three scenarios with rising ferocity. Finance minister Nirmala Sitharaman’s “dream budget”, aiming to return India to 7% GDP growth through massive capex, is in ruins with key assumptions destroyed. The budget assumed inflation would crash in 2022-23, with the GDP deflator falling from 8.4% to just 3%. That now looks like a fantasy. Oil is already at $100/barrel against the budgetary assumption of $75/barrel in 2022-23. 

The budget assumed GDP growth of 8% in the coming year. It may be no more than 5.5% in Scenario Two and 4% in Scenario Three. Slow growth will hit revenues even as inflation sends expenditure shooting up. Sitharaman claimed to have found “fiscal space” for a big investment push, but that has disappeared.

Stock markets will fall lower. The government will get much lower prices than hoped for in the LIC IPO, privatisation and monetisation of old infrastructure assets. Bond prices will fall, raising the cost of government borrowing. Sitharaman will ask the RBI to keep money easy to restore growth, but long-term interest rates look certain to rise anyway, deepening the woes of industry and borrowing consumers.

Scenarios Two and Three may have major political consequences. Today, inflation and unemployment are already hurting BJP’s prospects in the current state elections. If inflation worsens and the economy slows down — and job creation too — the BJP’s fortunes in the next state elections in Gujarat and Karnataka will take a knock. Scenario Three will cause long-term harm and endanger BJP’s prospects in the 2024 general election. 

Our politicians, companies and consumers are more at the mercy of global winds than most people realise. Might the Ukraine war do the unthinkable: Revive Rahul Gandhi’s fortunes?

This article was originally published in The Times of India on February 26, 2022.

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