Navigating economic uncertainties caused by Ukraine war

Context: The ongoing conflict between Ukraine and Russia is going to have a significant impact on emerging market economies, including India. The main concern largely comes from the impact of higher crude oil prices which has hit crude $139/bbl.

Present Macroeconomic situation of Emerging Countries including India

They are running current account deficits. They have witnessed depreciating currency and a hardening of interest rates.

Problems being faced by Emerging Market Situation (Apart from the consequences of Present Oil Prices)

US dollar is appreciating and US treasuries are strengthening. The US runs the largest current account deficit in the world (23 times higher than that of India). But, by this logic, US treasuries should now have been at all-time lows (But it is not so, because of Triffin paradox).

Triffin Paradox

The US current account deficit is purely a reflection of the US supplying large amounts of dollars to fulfil the world’s demand. There is also a “saving glut” i.e., emerging economies were accumulating foreign exchange reserves in dollars, and diverting domestic savings to buy US treasuries.

Analyzing Possible Solution

Global Analysis: the dominance of the US dollar is inevitable in the global financial architecture.  The dollar’s dominance will not decline ever in future as 90% of global trade is dollar-denominated. Also, the Renminbi and the Euro do not find a larger space in the foreign reserves’ basket of an emerging market economy today.

Domestic Analysis: We must find domestic solutions by managing our government finances better

Challenges in Domestic Solution

Although heavy interventions by the RBI in the foreign exchange market could pull the rupee up from the record lows. But the larger concern is how the government and the RBI will do so now. Because now the government is doing record government borrowings, and how to prevent domestic interest rates from hardening.

Way Ahead

First, the government and RBI may spread the borrowings of the government over four quarters of the financial year, instead of the traditional approach of completing 60 per cent of the borrowings in the first half of the year.

Second, The RBI and the government can induce market players to buy bonds in this uncertain time. Further, a higher proportion of short-and medium-tenor securities can be offered in the initial months of the year, while longer tenor securities can be offered in the second half of the year.

Third, the small savings collections are an important part of the government borrowing. Therefore, the government can encourage fresh registration in the small savings schemes such as the Sukanya Samriddhi Yojana (SSY)

Fourth, The Life Insurance Company (LIC) which holds a large share of government bonds. As a result, LIC’s listing should signal positively for the bond market. It is because the insurance behemoth may be forced to invest a larger portion of its inflows in safer domestic assets. The current market volatility could push investors readjust their exposure to countries like India.

Conclude

In such a scenario it is best to follow unconventional policy measures as those listed above to ensure that the government’s borrowing programme passes through with the least disruptions.

Source: This post is based on the article “Navigating economic uncertainties caused by Ukraine war” published in the Indian Express on 09^th March 2022