Note: This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.
After much debate about its desirability, the US bit the bullet and removed some leading Russian banks from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) messaging system. SWIFT connects over 11,000 banks in over 200 countries on a common transactional information platform.
This is possibly the harshest economic sanction against Russia to date.
Being removed from this system will cause much pain and disruption in Russia’s international trade conducted through its prominent banks. It is like SBI, Canara, HDFC and ICICI Bank – holding nearly 50% of Indian bank assets, including regular credit to large and small exporters – being suddenly thrown out of the global banking information system.
Iran is believed to have lost over 30-40% of its trade, including in oil and gas exports, when it was removed from SWIFT in 2012 after being sanctioned by the US.
News reports say President Joe Biden had to convince some key European Union nations before imposing the latest measure. Germany, which depends on Russian gas for over 30% of its needs, had legitimate concerns about the scale of disruption to energy exports from Russia. In a way, this was Putin’s trump card, which could potentially split the US and EU on the nature of sanctions. The US is nearly self-sufficient in energy.
Also watch: ‘Nightmare Scenario for India If US Decides Russian Threat Means Easing Up On China’: Shyam Saran
However, the US managed to find a middle ground with the EU, which is to punish Russia enough without totally incapacitating its energy trade. Throwing key Russian banks out of the SWIFT system will create ripples in markets, leading to further hardening of oil prices from the present elevated level. Crude has surged to $105 in response to Russian banks being removed from SWIFT, and the rouble is down 30% against the dollar.
Earlier, as global oil prices moved up, it produced the perverse outcome of Russia earning higher revenues for its oil/gas exports! So some calibrated cost had to be imposed on Russia. Throwing large Russian banks out of SWIFT will partially achieve that aim, hitting Russia’s oil revenues considerably. Oil, gas and related products account for nearly 50% of Russia’s exports and 35% of its GDP. The Western alliance would want to strategically target this but is also calculating the blowback to the global economy.
Putin may have anticipated this and created parallel trading and banking arrangements via China and other non-hostile countries, which are very few at present. Even North Korea has such subterranean arrangements to export its mineral resources. This is closely controlled by the political elite.
Putin had also been de-dollarising the Russian economy, with some help from China. This gathered pace after the 2020 pandemic when close to 45% of trade between China and Russia was non-dollar denominated. China has also been consciously conducting non-dollar trade with some countries. Partially de-dollarising mutual trade by conducting large transactions in local currencies was also actively discussed at the BRICS forum a few years ago.
Russian President Vladimir Putin arrives for a meeting with representatives of the business community at the Kremlin in Moscow, Russia February 24, 2022. Photo: Sputnik/Aleksey Nikolskyi/Kremlin via Reuters
Russia last year denominated the largest share of its foreign currency reserves in gold. It was the first country to have more official forex reserves in gold rather than in US dollars. Most large economies keep the largest chunk (over 50%) of their reserves in US dollars. It is seen as the safest hedge. However, it is yet to be seen how prepared Russia is to counter the overall impact of multiple sanctions. Russia’s stock market has fallen 35%, which may be an indicator of what lies ahead. We will know the full extent of damage to Russia’s economy in a few months, if no diplomatic solution is found. If Russia is badly hurt, higher energy costs will inflict pain on global markets. Food grain prices might also move up as Russia and Ukraine account for over 25% of global wheat production. The region is seen as Eurasia’s breadbasket.
From India’s perspective, both energy and food are very sensitive segments of the political economy. The first big hit will come after the Uttar Pradesh elections when the Modi government will be forced to adjust domestic petrol and diesel prices against international levels.
The last domestic price adjustment occurred on November 4, when crude was $75 per barrel. Since then, no domestic price increase has happened, primarily because of UP elections. After the UP polls, the Centre will either have to increase domestic petrol/diesel prices by 33% to align them with global crude prices or cut excise duty proportionately. Cutting excise will throw the government’s revenue assumptions out the window. If US sanctions on Russia last even two quarters, inflationary forces might spiral out of control. The rupee’s exchange rate could also decline sharply if global investors seek the safety of US treasury bonds.
Besides, global financial market disruptions could make it difficult to raise money. A former RBI governor told me that whenever there is panic and uncertainty in global financial markets, investors rush to the safety of US government bonds. This is not good news for stock markets in the developing world. Appetite for foreign direct investment or foreign participation in India’s divestment or asset monetisation programme may be tepid this year. Both the Centre and RBI will keep a hawk’s eye on food and energy price inflation in the next few quarters. Fiscal 2022-23 could well be about mere crisis management for most major economies.
In his reply to the President’s address, Prime Minister Narendra Modi mocked Nehru for citing the Korean War of 1952 as the reason for inflationary pressures in India. It will be no surprise if Modi ends up blaming the war over Ukraine for India’s economic woes in due course.
Nehru may yet have the last laugh.
