Macro Impact Overview: The current Russia – Ukraine crisis has certainly created macro dislocations in the global economic scenario which the FM Nirmala Sitharaman noted in her post budget interaction as posing risks to the financial stability of India. Disruptions in the supply chain has contributed to the surge in crude oil prices and resulting from the commodity price pressures India has witnessed higher inflation as well as depreciation pressure on the rupee. Certainly, the geopolitical tensions have contributed to a weakening of macro-economic sentiments with near term risk-off contributing to FPI outflows and broad-based selling particularly in equity indices and currency markets. While India accounts for < 1 % of Russia’s crude oil exports, India is heavily reliant on oil imports which account for 85% of oil requirements. Hence, sanctions on Russia which is the 3rd largest oil producer result in knock on effects for the India economy. The indirect impact through a higher oil-import bill in turn contributes to a worsening in the current account deficit as well as Consumer Price Index (CPI) inflation. India’s main non-military imports from Russia totalled $8.6 billion last year and principally comprise oil, fertilizer, coal and precious metals while India’s exports totalling $3.3 billion involve tea, coffee, electronics, iron and steel and auto parts. Banking and financial services comparatively is a much smaller slice.
As per latest figures, India’s CPI Y-o-Y Monthly is 6.1% and Current Account Deficit for the Quarter was at - $ US 38,320 Mil while FDI Outflows were – US $ 13,381 Mil. To understand this causality between crude prices, a widening current account deficit and real GDP growth rates we see how the Indian economy has behaved during periods of duress considering the post pandemic Covid economic scenario (2020-21) when crude oil futures had temporarily gone into backwardation. All these macro developments in turn have BFSI effects.
Impact analysis reveals that $10 increases in crude price per barrel would significantly impact CPI inflation by 176 bps, weaken real GDP by 30 bps and result in a US $ 910 billion worsening in the current account deficit.
As per latest estimates, in Q2 the current account deficit was 1.3% of GDP, $9.6 Billion and should crude prices breach $150 per barrel from current levels of above $100 and a $20 billion FPI outflow, the RBI will need to sell $30 billion of forex reserves to protect the rupee from depreciating. Since the onset of Covid coupled with the latest geopolitical tensions between Russia and Ukraine, while Average per barrel crude prices have risen 41% from 64.3 (2019) to 90.7 (2022), the rupee has witnessed roughly a 6% depreciation from levels of $/INR 70.4 (2019) till $/INR 74.73 (2022).
Reflective of these deteriorating macros on geopolitical tensions, the BSE Sensex over the course of the Russian Invasion of Ukraine has dropped nearly ~ 3350 points (5.8 % down) from 57684 to 544334 point to point. In comparison, over the same time frame, the NIFTY Bank Index has dropped nearly ~ 3278 points (8.7% down) from 37686 to 34408 point to point.
Impact on Indian Banks and Financials: It’s important to note the effect on rates. The RBI’s Monetary Policy committee (MPC) in its latest meet maintained the repo rate, short term lending rate for commercial banks at 4%, while the reverse repo rate was held at 3.35% and the marginal standing facility (MSF) rate and Bank rate at 4.25%. The recent Russia Ukraine geopolitical tensions and the upward pressure on inflation above the RBI’s comfort band given backdrop of deteriorating GDP growth and a widening current deficit has mandated that the RBI looks at raising repo rates which it has traditionally done when raising rates during crude oil price increases in 2010, 2011 and 2018. Further successive rate hikes of 25 bps are expected to take the repo rate to 4.75% by March 2023 in the absence of the government cutting excise duties.
As expected, a rate tightening in such a scenario whenever RBI has traditionally raised reverse repos, has contributed to banks getting more interest rates by parking money with the RBI which results in a commensurate drop in liquidity in the system in terms of credit disbursements and loans to businesses. However, banks have generally been able to pass on these rate hikes to customers in the form of higher interest on loans which contributes to Net Interest Income and the profitability trends as seen below. Analysis over the years in Key financial ratios of Indian financials is shown below against the key macro indicators and movements in crude from 2018-2022. Indian financials across the board have generally been on a strong footing across key metrics with improvements from 2018 seen in ROA and ROE profiles while Net Income Margins have seen margin expansion and there has been an improvement in annual revenue and net income growth.
Similarly, when doing a deeper dive into the large cap banks as a barometer of the Indian banking sector when analyzing the profitability metrics of State Bank of India and the major private lenders namely HDFC Bank, ICICI Bank, Kotak Mahindra Bank and Axis Bank, NI margins have been strong as have 1 year revenue growth and net income growth despite an inflationary environment and the crude rally amidst Ukraine Russia geopolitical tensions in a post pandemic economic scenario.
Indian Banks’ Exposure to Russia is Minimal
As per estimates, the impact on Indian banks is likely to be fairly insignificant as a result of the sanctions against Russia. State Bank of India (SBI) and mid-sized public sector bank Canara Bank have a joint venture in Russia called Commercial Indo Bank LLC, Moscow with State Bank of India owning 60% equity stake while Canara Bank owns 40%. Total loan exposure is less than Rs 400 Crore (US $ 53.71 Mil) with exposure shared 60:40.
- SBI’s Net Loans, Dec 31st 2021, were US $ 3,47,740 Mil and Russia exposure was only ~ US$ 32 Mil which was a mere 0.01% of total net loans portfolio.
- Canara Bank’s Net Loans, Dec 31st 2021, were US $ 92, 951 Mil and Russia exposure was only ~ US $ 21 Mil which was a mere 0.02 % of total net loans portfolio.
Similarly, there are no Indian banks that have branches in Russia and neither are there any representative offices of Indian banks in Russia. As such the only other way that Indian banks are potentially exposed to Russia – Ukraine is through funding to Indian exporters or importers that are linked to both countries.
Additionally, SBI has stopped processing transactions involving Russian entities facing international sanctions. SBI has also sought information from Indian oil companies given their exposure to Russia including stakes in Russian assets, funds received from Russia in the last year and lenders involved in routing these transactions, according to two senior energy industry sources to mitigate this fallout.
What about the SWIFT sanctions and how does this affect India?
As per latest sanctions, a select group of Russian banks have been blocked from SWIFT with wider ramifications for many of Russia’s leading lenders such as Sberbank and VTB Bank. As a result, India could potentially witness cancellations of supply orders and the potential issue of trading with Russia in dollars. However, India is currently exploring boosting rupee-rouble trading arrangements to manage these currency sanctions in a manner like that utilized to trade with sanction hit Iran.
Steps to manage this may involve Russian banks and companies opening accounts with a few state-run banks for trade settlement, and an arrangement which would involve partial settlement in Ruble and the rest through local rupee accounts are also being explored.
