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The Russian invasion of Ukraine is now entering its third week. With each passing day, Moscow’s apparent-but- denied objective of regime change in Ukraine appears to be increasing the threat of regime change in Russia itself. In addition to the possible reaction of President Vladmir Putin’s inner circle to an intractable war, the primary reason for this is the crushing weight of Western sanctions on Russia and the inevitability of an economic recession, possibly even a depression, in that country.

Wars are usually costly and inflationary both. By some estimates, this war is costing Russia about $20 billion a day, The inflationary impact of increased demand for military goods and mobilization is being compounded by the economic isolation of sanctions from the much of the world in terms of money, goods and services. While Russia’s military is on the offensive, its central bank is playing defence.

Elvira Nabiullina is the president of the Central Bank of Russia. She famously wears a brooch to signify the economic mood of the country. For example, she wore brooches that depicted a dove and hawk to signify easing and tightening during the pandemic. The Russian rouble plummeted from about 83 to $1 just before the invasion to 133 by day 17, a decline of nearly 40%. Partly to defend banks against a run on their deposits, Nabiullina hiked interest rates. She wore funerary black at the meeting that announced a hike in rouble interest rates from 9.5% to 20%. This huge hike may or may not stop capital flight, but is very likely to sharply reduce economic activity, particularly if it is credit related. Russia’s economy, which was the second largest after the US’s at the height of Soviet power in the 1950s and 1960s, would have fallen to 22nd in the world with this rouble drop, and could fall further with shrinking economic growth.

Household consumption is also likely to plummet with a decline in jobs, wages and purchasing power. Over 300 Western companies have already suspended operations in Russia. The long list includes household names like McDonald’s, Coca-Cola and Starbucks, technology companies such as Apple, Microsoft and SAP, and auto companies like Volkswagen and Toyota. Cogent Communication, which is the second largest internet provider in Russia, have also announced the disconnection of its “backbone" into and out of the country. This action is likely to hasten the ‘splinternet’—the worry that the global internet will splinter into strategic blocs. As of now, many companies are retaining and paying their employees. McDonalds’s, for instance, continues to pay its 62,000 staff in Russia. However, the longer the war and/or the sanctions continue, employees will eventually end up losing their jobs.

Russia has run large trade surpluses for the last 30 years and yet its foreign assets are only moderately more than its liabilities. Analysts believe that the difference can be accounted for by money parked abroad by Russian oligarchs and other members of the establishment. The move by the West to sanction oligarchs and individuals in government is directly related to “confiscating" these assets. In a paper published in 2018, Novokmet, Piketty and Zucman estimate that assets held abroad are approximately three times the net foreign reserves held by the Russian central bank and exceed the total financial assets of all households in Russia. So, the Russian establishment has a lot to lose if those assets can be identified by sanction-imposers accurately.

The cost of insurance against a Russian government debt default has soared by over 50%. Russian 5-year credit default swaps (CDS) rose to a record 4,200 basis points last week, signifying a very high probability of default. While global bond holders of Russian government and corporate credit are likely to get into protracted negotiation over whether they will be paid in roubles or US dollars, the simple fact is that a collapsing and isolated economy will likely head towards default. In the meanwhile, Russian stocks on international stock exchanges have declined well over 90%. The Russian stock exchange index has fallen over 30% in local currency terms, creating a drag on the economy from a negative wealth effect. A poll of polls suggests that Russian gross domestic product (GDP) will fall by 8% and inflation will surge to 20% in 2022. If the war drags on and more countries join the sanctions regime, then its GDP could drop significantly more.

Given the depth and breadth of our defence procurement from Russia, India had no choice but to abstain during the United Nations vote condemning the Russian aggression. With the impending collapse of the Russian economy and the unpredictable political consequences that will entail, India must actively consider Plan B and Plan C. Under Plan B, India continues to remain a ‘swing power’ with issue-based alignment with other countries; with the West geo-strategically against China and Beijing against the West on trade-related agricultural subsidies, India can fast-track its ability to hedge supply chains for Russian-made weapons that make up a significant portion of its arsenal. Plan C will have to consider the hitherto heretical proposition that India aligns more firmly with the West. Each of these is a tough choice with many implications for now and the future. The planning should start now.

P.S: “When my information changes, I alter my conclusions," John Maynard Keynes is said to have said.

Narayan Ramachandran is chairman, InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand

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