The West Asia war has been on for two months and has caused considerable disruption across the world. The question is when will it end? There is no answer here as what was expected to end in no more than a month’s time has gotten prolonged with even more uncertainty.
At the physical level, there has been disruption in supply of goods, primarily oil related, while transport services (both sea and air) have been affected. While alternatives for the latter have been gradually mediated, the shortages in supply of oil and gas is still a major challenge.
In this situation how has India done?
The short answer is that we have done rather well given the conditions. But there are two aspects here. The first is the real economy, which has been managed astutely by the government. The second is sentiment as reflected in the market. Here the regulator, Reserve Bank of India (RBI) has been monitoring the currency and bond markets and plugged all possible volatile elements. But beyond a point, the market rules have prevailed.
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At the real economy level, while sectors would be affected which in turn will affect consumption and investment, the overall edifice is resilient as seen by the RBI forecast of 6.9 per cent in gross domestic product (GDP) growth. There have been supply disruptions in the form of gas supply, which has affected fertilizers' production.
Efforts are on to increase imports so that the kharif crop is protected. In fact, the supply of LPG has been handled well with rationing being initially pursued as domestic production was also increased. While the restaurant business was affected to begin with, there are signs of things going back to normal very gradually though cost increase is unavoidable.
Sectors such as paints, glass, ceramics, pesticides, fertilizers, automotive among others have faced supply side challenges that are being gradually addressed. They would remain vulnerable until such time that the war is on.
More importantly, the inflation has been kept under control as of now with the government absorbing a large part of the crude oil cost increase and protecting the consumer. This will mean a hit to the fiscal numbers, and will hence be a challenge for the government going forward. RBI's forecast of 4.6 per cent for the year does indicate that inflation will be higher, though not going out of hand.
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But in this environment, private investment is bound to turn cautious which will be the second successive year where only some sectors will see an uptick. Last year, the tariffs imposed by the US did come in the way of investment. This time it is the war.
Unpredictable markets
On the markets side, things have been more explosive. The stock market has been extremely volatile with the Sensex declining from the 80,000-plus levels. The gyrations are in response to any news on the political front and hence makes things unpredictable.
The 10-year bond yield has risen from the 6.60-70 per cent range prior to the commencement of the war to 6.80-7 per cent in April. While the RBI has ensured there is surplus and comfortable liquidity the market has priced in higher borrowings of the government due to slippages in revenue (excise cut, lower profits and tax payments from OMCs) and higher subsidy on fertilizers (possibly 20 per cent higher than budgeted). Also with higher US treasury yields, the spread of 230-250 bps is being maintained.
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On the currency side, the RBI has been nimble footed in terms of operations in the spot, forward and NDF markets as well as with fine-tuned regulation to control speculative activity. While the rupee has remained range bound with the Rs 93-94.5/$ rate being maintained, the foreign currency reserves have come down by around $ 16 bn which can be taken as the cost of forex management.
A prolonged war will mean a downside to GDP growth, an upside to inflation and extremely uncertain markets. This also means that the interest rate cut cycle could well be over.
Madan Sabnavis is the Chief Economist, Bank of Baroda and author of: Corporate Quirks: The darker side of the sun. View are personal.