By Kaushik Bhattacharya and Rudra Sensarma
The Ukraine war is arguably the biggest threat to globalisation in recent times. As an inevitable fallout of this war, the unipolar world of yesteryears is now turning into a multipolar one, posing new economic and political challenges to emerging markets. Specifically, what are India’s challenges on the external economic front and our imminent policy options?
The Ukraine war is expected to bring permanent changes in the pattern and the extent of global trade. According to a recent report from UNCTAD, global merchandise trade has decreased in terms of volume, but increased in terms of value in Q1 2022. If the war prolongs, this trend is likely to continue as many countries will try to become more and more self-reliant in food and energy. Moreover, to overcome global economic and political shocks, trade is more likely to get concentrated among ‘friendly’ nations.
On food items, India is currently self-reliant in most of the products. Some essential commodities like sunflower oil and palm oil that are currently imported can be substituted by domestic alternatives. India is planning to increase its palm oil production using agricultural land in the North East and Andaman and Nicobar Islands. Rice bran oil is another option as it does not have the environmental concerns associated with palm oil production and, being a by-product of rice milling, it is easier to produce.
India’s situation with respect to energy, however, is different. The government must incentivise domestic gas production by liberalising prices and investing more in renewable and nuclear energy. The share of the latter two in India’s primary energy mix is around 1 percent each while it is around 10 percent each in USA. Even the share of natural gas (6 percent) is much lower than that in other countries.
The government aims to boost the share of natural gas to 15 percent and increase nuclear power capacity threefold by 2030. This is a step in right direction given the current troubles a developed country like Germany is experiencing due to its decision to shut down several of its nuclear power plants. Germany’s over-dependence of energy on Russia is a lesson for all countries in the world. In the short-run, India must hedge its political risk by diversifying sources of energy imports. In the long-run, an attempt must be made to enhance capacity in this sector.
The increasing self-reliance and groupings in global trade that the Ukraine war has unleashed has important implications for management of forex (foreign exchange) reserves. It may be noted that a completely closed economy will not need any forex reserves! Greater self-reliance is, therefore, expected to lead to less demand for forex reserves globally. Not only the amount, the compositions of the reserve baskets of countries may also change significantly. One of the consequences of freezing of Russia’s forex assets by the West is that many countries will diversify their financial assets from US Dollar (USD) and Euro to other currencies.
According to a recent survey by UBS Asset Management, the dollar’s share of global foreign exchange reserves has fallen down from 69 percent in June 2021 to 63 percent in June 2022. The same survey also reported that central banks are on average looking to hold about 5.8 percent of their reserves in the Yuan in 10 years’ time, compared to the current level of 2.9 percent. We may expect this gradual shift to other assets to continue. India needs to monitor this trend carefully and hedge its own risk through appropriate diversification.
It is well known that global currencies like the USD and the Euro are needed not just as safety cushions, but also for regular transactions. However, here too we observe a discernible global shift towards other currencies. Recently, Russia and China have de-dollarized trade between them. Some Asian countries like India, Indonesia, Sri Lanka, Myanmar and the UAE are reportedly in talks for settling trade in their domestic currencies.
In future, it is likely that regional trade blocs will increasingly use one or more of their own currencies in regular economic transactions. This trend can reduce transaction demand for major global currencies further. Recently, the RBI allowed export invoicing in rupees which could be a precursor to trade settlement in rupees with close trade partners. This is a step in the right direction as India must take the opportunity to internationalize its own currency, if not in all parts of the world but at least in its own sphere of influence.
Importantly, freezing of Russia’s forex reserves is expected to lead to changes not just in amount and composition of central bank assets, but also in their physical location. Anecdotal evidences suggest that in the past many countries maintained a significant part of their reserves in the form of deposits in large Western banks or delegated the management of their reserves to the BIS. The Ukraine war may lead to a lasting change from this arrangement.
To hedge political risk, countries may now prefer to diversify their foreign assets across banks of different countries and in locations where they will have more control. India must monitor this development to make its economy sanction proof. Such a strategy is also necessary to mitigate financial risk against any possible global banking crisis in future.
Internationally, many of these developments are contingent on the actions of major emerging market countries like the BRICS. There is an ongoing discussion in BRICS to float its own reserve currency. If this and the parallel effort of challenging the monopoly of SWIFT by some of these countries become successful, then the financial hegemony of the West will reduce significantly.
Currently, a major argument against BRICS currencies is their non-convertibility on capital accounts. However, freezing of the asset of a country is also an extreme form of capital control, whatever be the ethical justification for it. Further, wars exacerbate extreme policies like capital control. India must prepare itself for all such eventualities. Being a part of the efforts in the BRICS forum, without being too strident against the West, would be of huge advantage to India, giving us more options.
Parallel to the Ukraine crisis, another war is being continuously fought in the financial world. The challenger here is China with its stated goal of internationalization of its own Renminbi against the USD. An interesting question here is whether China will free itself from the US Dollar in the near future and if so, how? It may be noted that foreign holding of US debt is not the major part of the overall debt of the US. So even if China starts dumping USD, the US economy may still absorb the shock, but there could be a significant cost to China.
Alternatively, China may consider two policy options. First, being energy deficient, it may spend a significant part of its reserves making its domestic economy less dependent on oil and gas. Second, China may develop a string of land and naval bases in the world, using a part of its reserves. This can take the form of formal buying/leasing of ports and land from small economies, especially islands (e.g., Solomon Islands). Chinese buying/leasing along with its lending and doles can make many such economies rich overnight and buy China more influence. If China opts for the second path, the war of influence may escalate to other zones, leading to greater economic and political fragmentation in the world. Currently, India is not in a position to compete with China to ‘purchase’ influence globally. However, India needs to be wary of this development, especially in its own area of influence. Politically, it may not be in India’s interest to yield ground without a fight.
On balance, a multipolar world with more equality at the global level will be of enormous advantage to India despite a visible threat from China in the neighbourhood. Politically, the best hope for India is to use its soft power and create win-win situations everywhere. This option, however, would demand careful balancing among the existing poles. India has a long history of non-alignment and in the past has managed that balancing act successfully, that too with a small domestic economy. This time however, India has the lure of a big market and it is a great tool to turn enemies into friends overnight from all walks of life.
(The authors Kaushik Bhattacharya and Rudra Sensarma are Professors of Economics at Indian Institute of Management Lucknow and Indian Institute of Management Kozhikode, respectively. Views expressed here are personal.)