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Monday, October 3, 2022

External headwinds from China, rising crude prices pose fresh threat to economy

External headwinds such as a renewed rise in international crude oil prices and an economic slowdown in China may pose fresh threats to the global and Indian economy, two policymakers said. The government will tackle them with fiscal and monetary measures with continued focus on taming inflation, driving growth and converting challenges into opportunities, they added.

Although the developments are external, the finance ministry and the Reserve Bank of India (RBI) are watchful and will respond accordingly, the officials said, requesting anonymity. They hinted at further tightening of liquidity, export curbs on essential commodities, focus on import substitution and an aggressive push to make India a key part of global supply chains.

Benchmark Brent crude, which fell below $95 a barrel on August 4 and touched a low of $92.34 in mid-month, bounced back to above $100 last week. India, which imports 85% of its crude oil requirements, saw its daily average import cost at $99.96 a barrel on August 25, a 9.3% jump since August 17 ($91.45). Global oil prices are rising, fearing production cuts by the Organisation of the Petroleum Exporting Countries, a producers’ cartel.

Rising fuel prices is a concern for both the finance ministry and RBI, as they have an impact on inflation. After hitting a peak of 7.8% in April, India’s retail inflation has gradually moderated to 6.71% in July, but remains higher than RBI’s upper tolerance limit of 6%.

The latest edition of the finance ministry’s Monthly Economic Review also spoke about these risks. “The geopolitical environment remains tense and fraught. This could trigger fresh supply concerns in the winter for critical commodities such as crude oil and natural gas. The Chinese economy is struggling and the central bank has unexpectedly lowered its policy rate signalling serious worries about growth,” the report, released on August 19 said.

The International Monetary Fund in July revised China’s growth to 3.3% in 2022 from 4.8% forecast in January.

“The China shadow is going to affect the global economy,” one of the policymakers said.

As India and China are major trading partners, the development will certainly impact India, but it also provides opportunities, he added, citing India’s recent free trade agreements with the United Arab Emirates (UAE) and Australia, and New Delhi’s free trade talks with the UK and the European Union.

India’s total merchandise export to and import from China in 2021-22 was $21.26 billion and $94.57 billion, respectively, official data show.

The Chinese slowdown will adversely impact India’s exports, but also provide it opportunities, said Ranen Banerjee, partner and leader of economic advisory services at PwC India, a consultancy. “The turbulence in the Chinese economy and the geopolitical developments may make investors nervous about further investments in China, and India could benefit from that by way of redirection.”

“The Chinese slowdown may have a short term adverse impact on the Indian economy, but it may imply lasting long-term benefits as appropriate substitution effects are generated,” said DK Srivastava, chief policy adviser at consultancy firm EY India. “India has the capacity to manufacture most of the intermediate products that are currently being sourced from China. Imports of final goods from China should, in any case, be discontinued through additional tariffs and other quantitative measures.”

Experts are, however, concerned about inflation. Inflation is weighing not only on consumers but on businesses as well, according to Rumki Majumdar, an economist at Deloitte India, a consultancy. “Operation and logistics costs are escalating, impacting margins,” Majumdar said.

“Supply disruptions will continue to impact trade and manufacturing sectors from electronics to pharmaceuticals, thereby, keeping pressure on the prices of essential intermediate components and inputs,” Majumdar added. “On the other hand, a possible slowdown in the economies on both sides of the Atlantic and in China could trigger a downturn in the commodity market cycle, therefore, lifting some of the price pressure.”

The volatility in crude oil prices remains a concern for experts. “If the global crude prices continue increasing, its effect would be transmitted to India’s CPI (consumer price index) inflation through the average price of the Indian crude basket. This may absorb some of the increases in the global crude prices and the effect may also be lagged,” Srivastava said. “However, a persistent increase in global crude prices would eventually translate to pressure on CPI inflation.”

In the coming months, if the OPEC plus countries increase their output, or if Iran comes on board after a suitable resolution of the ongoing negotiations regarding its nuclear facilities, there would be a lowering of inflationary pressures in India, he said. However, there is considerable uncertainty in these exogenous factors, he added.

“Domestically, there is the option of further reducing excise duties and value-added tax on petroleum products to mitigate these pressures,” Srivastava said. “On the whole, there is a likelihood that RBI’s assessment of annual CPI inflation of 6.7% may not be exceeded significantly.”

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