A report by State Bank of India (SBI) economists said that irrespective of military objectives, the impact of the conflict will be felt across commodities and asset classes.
Russia’s invasion of Ukraine on Thursday caused crude oil prices to surge above $100 a barrel for the first time since 2014, with Brent touching $105, before paring gains by the close of trade.
The assault was the biggest attack on a European state since World War II, prompting tens of thousands of people to flee their homes.
The report highlighted historical trends which indicate that it takes around 18 months for crude prices to crash by as much 67 per cent from the highest level. It said that 30 per cent drop from highest level could come in less than 3 months.
“Thus, the decline in crude prices from the current high levels could come even faster going by the recent trends and it augurs positive for overall macro prognosis,” it said.
Impact on government
The report further estimates that if crude prices rise to an average of $100 per barrel, then inflation is likely to increase by 52-65 basis points (bps).
The average price of Indian basket of crude oil jumped by 33.5 per cent to $84.67 per barrel in January from $63.4 per barrel in April 2021.
Prices of petrol and diesel have remained the same since November last year when the Centre reduced excise duty on both. As a result, many states followed suit by providing additional reduction in form of reduced value added tax (VAT).
SBI economists assume that if VAT structure remains the same and crude oil prices stay between $100-$110 per barrel, diesel and petrol prices should have been higher by Rs 9-14 each by now.
It is highly anticipated now that oil marketing companies (OMCs) may increase prices in March after completion of ongoing election in 5 states.
If government decides to reduce excise duty on petroleum products further by Rs 7 per litre and prevent fuel prices from rising, then it will incur an excise duty loss of Rs 8,000 crore for a month.
Secondly, SBI economists assumed that if reduced excise duty continues in the next fiscal and petrol, diesel consumption grows around 8-10 per cent in FY23, then the revenue government would incur a loss of around Rs 95,000 crore to Rs 1 lakh crore.
Upside risks to inflation
Other commodities on which impact of inflation can be seen include precious metals gold, palladium and platinum.
Besides, Ukraine is an important exporter of agriculture products. Hence, the report expects an impact on prices of wheat and corn, if navigation lines in Black Sea are disturbed.
“For India which has no strategic interest in this conflict the fall out will be mostly economic,” the report said.
Apart from impact on current account deficit (CAD) from rising commodity prices, the sanctions on Russia may also impact regular trade (eg. tea) between the India and Russia.
The export outlook of services towards Europe will be impacted negatively, it said.
Consumer price inflation (CPI) accelerated to 6.01 per cent in January.
Expecting brent prices to rise further, the report expects upside risks to inflation.
It says every $10 per barrel rise in crude prices will lead to rise in inflation by 20-25 bps.
Besides, it highlighted the gap between whole sale price inflation (WPI) and CPI as there has been incomplete pass-through with WPI food much higher than the CPI food since November 2021.
The gap between the two has increased to 4.7 per cent in January 2022. Vegetables have the highest gap between WPI and CPI, followed by eggs and fruits.
Regarding services inflation, the report showed that health CPI is on the higher side but is lower than during the second wave’s peak level. It will continue to remain around this level unless India is hit by another wave.
Overall service CPI, excluding housing could increase by 10-12 bps on account of complete opening of the economy, it said.
Another component which could see increase in inflation on account of increase in demand post the complete opening of the economy is housing.
The report said that once all offices start resuming office and abolish work from home, there will be an increase in demand for rental accommodations which in turn would lead to increase in CPI as house rent, garage rent has huge weight 9.51 per cent in overall CPI.
Combining all these factors, there appears to be an upside risk of 87-100 bps to RBI’s inflation of 4.5 per cent for FY23 if oil price averages to $90 per barrel and 107-127 bps upside if oil price averages to $100 per barrel.