West Asia crisis can hit global economy

THE Israel-Hamas war is bound to impact global economy, which is already sluggish. The ramifications will become clearer in the days to come, but a surge in oil prices has already begun and broader economic outcomes seem to be inevitable. The US Federal Reserve recently paused its cycle of rate hikes as inflation has been cooling down in the world’s largest economy. Emerging economies like India cannot remain immune to these developments. It was only last week that the Reserve Bank of India Governor, Shaktikanta Das, spoke about the slowdown in the external environment and warned of headwinds from geopolitical tensions that could upset the domestic economic outlook. The conflagration in West Asia could well overturn projections of improved economic growth in the current financial year. It could also dent the country’s reputation of remaining relatively impervious to challenging geopolitical scenarios.

The conflagration in West Asia could well overturn projections of improved domestic economic growth in the current financial year.

The central bank Governor had been sanguine in his forecast for the country’s growth in 2023-24, even describing it as the “new growth engine of the world”. Reiterating the expectation of 6.5 per cent GDP growth for the year, he included geopolitical tensions and geoeconomic fragmentations among the risks to the outlook. With the outbreak of a second major international conflict, there will be repercussions. As for the Ukraine war, it is already in its second year and there seem to be dim chances of any early end to the strife there.

In this backdrop, it looks as if several faultlines in the economy could get aggravated in the months to come. The first would be merchandise exports, which have already been contracting in the past nine months. Over the first five months of the current fiscal — April to August — total merchandise exports reached $172.95 billion compared to $196.33 billion over the same period last year. The slowdown reflects reduced demand from major markets like Europe and the US where recessionary trends have gained ground after the conflict commenced in Ukraine. High inflation and aggressive rate hikes by central banks have been contributory factors.

Services exports had compensated for this decline but even these are now dipping slightly. They had fallen from $26.5 billion last year in August to $26.3 billion in the same month this year. The negative trend is due to the impact of the high interest rate environment in developed economies like the US which has constrained corporate expenditures. While it is still early days, the Israel-Hamas conflict could conceivably worsen the situation.

Another weak spot for the Indian economy is crude oil, with over 85 per cent of its needs having to be procured from abroad. International oil markets have been on a rollercoaster ride ever since the Ukraine war erupted in February last year. Prices shot up at the time but moderated after a few months. A softening trend had begun by the beginning of 2023 and prices had reached $75-80 per barrel by June, a manageable level for this country’s exchequer. Saudi Arabia and Russia, however, pushed for more production cuts in July by the oil cartel OPEC+. These were extended in early September, leading to a price spike. There was a softening trend last week, based on lower demand forecasts, but the West Asian war has led to another surge in world markets.

A careful watch will now also have to be kept on the current account deficit as the combination of rising oil import bills and slowing exports could end up widening it. This has eased lately from 2.1 per cent of GDP in 2022-23 to an acceptable level of 1.1 per cent of GDP in the first quarter (April to June) in 2023-24. But it could expand in case oil prices fail to cool and exports do not pick up pace this year.

Inflation is another potential roadblock in the path towards high growth in the current fiscal. If the latest conflict is not resolved soon, there are bound to be more supply chain disruptions. These had a significant impact on industrial output last year in the wake of the Ukraine war. Similar issues could arise in case the present crisis expands and involves other countries.

For the time being, the central bank is confident that near-term inflation will soften on the back of vegetable price correction and the reduction in LPG prices. In terms of the future trajectory, the RBI says it is keeping its eyes on food products like pulses, vegetables and spices. But it is also concerned about El Nino conditions, and global food and energy prices along with financial market volatility. The latest external developments, however, show that geopolitical tensions are likely to play a far greater role in creating inflationary pressures than had been envisaged earlier.

The immediate reaction to the war playing out in West Asia has been a fall in domestic stock markets which are always sensitive to international crises. These may recover on the back of the improved demand within the country despite the uneven monsoon. Right now, the industry is looking forward to a buoyant festival season with sales of a wide range of products including passenger cars and fast moving consumer goods (FMCG) already reported to be rising rapidly.

The upbeat domestic economic activity has been in contrast to the relatively gloomy global outlook in recent times. The world economy has been in the doldrums for several years now with the pandemic creating upheavals followed by the Ukraine war. The International Monetary Fund has already scaled down global growth projections from 3.5 per cent in 2022 to 3 per cent in 2023 and 2.9 per cent in 2024. The outlook is again looking ominous amid the latest geopolitical tensions.

As for India, even external agencies like the World Bank have lauded its resilience in the backdrop of a challenging global environment. The question is: Can it retain such stability in the face of external headwinds that could affect is ability to stay on a high growth path? The answer will depend largely on whether the crisis in West Asia can be doused in the short run or whether it will expand to a wider arena.