War and India’s Fisc

Climate experts say, that the flutter of a butterfly in Hawaii might cause a cyclone in distant Mumbai! Such is the intricate interdependence of global climate systems. Present day economic interdependence between nations is no different despite nation-states claiming sovereignty over their zealously guarded territories. Russia’s invasion of Ukraine is still raging after over a month and economies across the globe are impacted while some of them severely so. At the moment the biggest sufferer in economic terms seems to be Russia. Inflation has risen by more than 16% and Russia has been forced to double the policy interest rate from 10% to 20% as it is not able to borrow from western financial markets and there is fear of capital flight from Russia. The Russian stock market was closed indefinitely from 25^th February and had a truncated session on 24^th of March with only 33 companies trading with a ban on foreigners pulling out their investments and on short sales of any kind. Russian government is reportedly using $10 bn from its sovereign wealth fund to shore up the value of shares of domestic companies in the market. Russian sovereign debt is reduced to junk status by rating agencies which expect it to experience negative growth for several quarters.

 But Russia still has $ 630 bn of foreign exchange reserves which can finance its import for about 2 years. More significantly a slow but expanding trade and economic cooperation between Russia & China is clearly gathering momentum. Being complementary economies, such an axis could soften the blow of sanctions on either of them. Russia can also access China’s Cross border Inter-bank Payment System (CIPS), if it is kept out of the SWIFT system. Over time this may weaken the role of the US dollar and strengthen the role of the Yuan as one of the reserve currencies of the world. 

India, however, seems to be ploughing its lonely furrow. India does face a moral dilemma. But its economic interests dictate a neutral stance. It is difficult for a country which imports 85% of its crude oil requirements, not to avail of the $20 to 24 discount that a sanction hit Russia is offering on crude. With Western manufacturers quitting, Indian pharma sector finds a huge market opening up for it in Russia. Over 90% of India’s defense equipment is of Russian origin and Russia has been the cheapest supplier of defense hardware to India over the last several decades. While ONGC, OIL India, IOC and BPCL have invested in upstream oil and natural gas assets in Russia, Russian oil major PJSC Rosneft Oil Company owns 49.13% stake in Nayara Energy Ltd (formerly Essar Oil Ltd). On the other hand, US is India’s largest trading partner. In April-January 2021-22, India’s total trade with the US was worth $96.61bn of which exports accounted for $62.27 bn. Indian banks and companies have more exposure in the US than either in China or Russia and it can hardly ignore its large student community and US investors in our market and growing tech-driven industry that mainly depends on the US and the West.  Nevertheless, as a growing, commodities hungry, energy intensive economy which imports bulk of its oil and gas requirements not to speak of edible oils and other commodities, India remains vulnerable to the disruptions caused by the war. Given the worsening global supply side disruptions, FY 2023 budget only recently tabled in the parliament looks outdated already and many of its outlays may have to reworked

1. The budget has reckoned with a price level of $70-75 for a barrel of crude. The price now is ranging between $100 to 140. Domestic fuel prices have started rising. Only recently the government had reduced excise duty on petrol and diesel by Rs.10 and Rs.5 a litre, respectively. Given the spectre of inflation and consequent political fallout, it may be compelled to reduce duties further. This will cause the fiscal deficit to breach the budget estimates.
2. The hike in crude prices is bound to increase the provision for fertilizer subsidy. Budget has cut back fertilizer subsidy by 25000 crores for FY23 from the revised figure of 1.4 lac crores in FY22 (which itself has again been increased by 15000 crores by the third supplementary demand). But this cut back has to be revisited if the government wants to arrest increase in farming costs and upward pressure on inflation.
3. Disinvestment performance, to say the least, has been dismal, notwithstanding the glib justification offered by a ponderous bureaucracy for missing disinvestment targets in budget after budget. It does appear like a bureaucratic ruse to adequately dress up the deficit figures at least initially! This time again, war induced volatile economic conditions percolating to the capital markets have scuttled the much touted LIC’s disinvestment plan. This means that even the drastically lowered disinvestment target of 65000 crores for FY22 will not be achieved. The resultant increase in fiscal deficit for FY22 will be much larger forcing the government to borrow much more than planned.
4. Budget for FY23 was hailed for the massive hike in capital outlay at 7.5 lac crores, higher by 35% than the budget estimate of 5.54 lac crores for FY22. At the best of times, substantial portion of the capital outlays have remained just on paper, implementation being the key challenge. As per Ministry of Statistics and Project Implementation (MOSPI), as of 2020, of the 1679 projects with outlays in excess of 150 crores, which are currently underway, 439 projects reported cost overruns and 541 were delayed. The average delay (time overrun) was 33 months, because of which the estimated cost of implementation has risen by 4.38 lac crores. One cannot but speculate how much of the much advertised 7.5 lac crore outlay will end up as an arcane figure in MOSPI report.

But even if implementation challenge is met, the rise in prices of commodities would mean that either the capital outlay will have to be increased or the number of projects envisaged in the budget would have to be reduced to contain the cost escalation in the wake of the war, which is estimated to be around 10%. The scaling up of the outlay would increase the budgeted expenditure which coupled with lower revenue will further stress the deficit. Given its massive borrowing programme, cost of borrowing for the government is escalating in spite of RBI efforts to contain the same. The budget has pegged the fiscal deficit at 6.4% of the GDP, at which government has to borrow close to 12 lac crores in FY 23. Sensing this the bond yields in the debt market have already gone up and market operators expect the yield on 10 year GOI Bond to flirt with 7% before long. The countervailing measures by RBI to arrest bond yields will be increasingly blunted in the impending inflationary milieu. One way to increase demand for government bonds and thereby soften yields is to include select GOI bonds in the MSCI Global Bond Index. But the mandarins in Delhi fear a loss of control on yields with foreigners holding a good chunk of government debt, which as of now is largely domestic. In any case, in the prevailing “risk off” sentiment for the emerging market debt, coupled with interest hikes in most developed economies lead by Fed, as also the heightened uncertainty caused by the Ukraine war, the opportunity for global listing of Indian bonds has passed us by for the time being. The result of all this is that future budgets will have to earmark ever increasing outlays to service burgeoning government debt. Well, the so called debt trap is no longer just a matter of esoteric discussion among public finance experts, but could be a reality soon with 43% of the budgeted revenue having been preempted by interest payment obligations, in the current budget itself.