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The opportunity for India in the changing world order


War is eternally bad, no matter what the motivation. And yet, here we are, with Russia invading Ukraine and a war that threatens to become WW3. There’s a bunch of things happening so this will be a long post. Here’s what we’ll speak about

  • The financial sanctions that hit Russia: why it’s a wake up call for India
  • The SWIFT cut-off and hitting reserves: the overnight loss of trust
  • Can India leverage the rupee for transactions outside India?
  • India’s exposure to the war torn countries
  • Inflation in the world and who’s going to help cope?
  • Bracing for inevitable, massive defaults in the credit markets

The financial sanctions of Russia

Russia invaded Ukraine. We all know that. We don’t really know why. The explanations go from:

  • Putin is a madman
  • Russia doesn’t want NATO to come to Ukraine
  • Ukraine has biological weapons
  • Russia wants the USSR to become one again
  • Putin is a madman



The truth is outside the syllabus. Therefore we get insane levels of propaganda from both sides – the Russians, whose propaganda is unfortunately in Russian, sounds like they are seriously short of vowels. The rest of the western world has rallied with Ukraine, and their propaganda is just as insane, but with more vowels. There is work being done to reduce the flow of propaganda from the Russian side to the world (Twitter, Facebook etc have banned pro-russian accounts) and thus, what you get is outrage that sounds stupid because you could replace Ukraine with Iraq and the silence was deafening.

Yet, the problem is not propaganda. The problem is that the western world has decided to sanction Russia in different, dark and dangerous ways.

They’ve done a bunch of things:

  • Russian banks have been removed from the International transaction system: SWIFT (Except for gazprombank which takes payments for the oil that other countries, in the west, buy from Russia)
  • Many US based payment systems like Paypal, Visa and Mastercard withdrew from Russia
  • The west wants to sequester Russian central bank reserves (around $300 bn) which is in USD, EUR and other currencies
  • The US is banning all oil and gas imports from Russia (around 8% of the US petroleum imports are from Russia) as is the UK (where it’s 6%). But not Germany yet (where it’s 30%+) or indeed most of Europe.
  • Many western countries have sequestered assets of rich Russians like yachts and so on. Example: Roman Abhahamovich owned Chelsea football club, and now that’s been frozen, so the club cannot be sold. In fact it can barely operate its accounts, and cannot access money given by Roman.
  • Large western brands like McDonalds, Mercedes etc. have withdrawn from Russia. Russia on the other hand has said that if such companies do this, they will take over the company’s assets in Russia.
  • The US, EU and UK have banned a lot of business with Russia, some of which include bans on exports of certain goods, no use of airspace by any Russian flight etc.
  • The west wants to even warn China and possibly India, on not allowing Russia to go around the sanctions. China’s been quiet but largely told the west they can keep shouting and it won’t really matter.

These things create a serious set of issues, and we’ll explore. But first, we have to understand why this is a problem for India, specifically.

Why is this a problem for India?

Russia has invaded Ukraine, for whatever reason. The US invaded Iraq for a very flimsy reason (proved wrong later) and refused to get out. They also invaded Afghanistan and left it a sordid mess. For us in India, it seems like one country invading another, and all of them seem roughly the same, just that a different ethnicity is involved in Ukraine. But to the west it appears that Russia’s actions are insane, but the US actions are not. This means they are happy to be hypocritical and unfair, which does not bode well for India, which already receives substantially unfair treatment from much of the west. So tomorrow if they decide something in, say, Kashmir is not to their liking, they could go bonkers and do this to us just as easily.

The threat is real, and while this time it took an invasion by Russia, it’s useful to be paranoid and say that for India, it’s important to protect itself. We’ll come to what that means, but it’s a threat India should not take lightly.  Now it’s important to get into the nuances.

What the SWIFT blockade means

World trade is denominated in dollars. Dollars can ONLY exist in US banks. Any sovereign currency can only exist in banks inside the country that issues it. Anyone that owns euros, owns it in a bank in Europe. Sure, they may think they own it in their bank in India, which has an account (called a “Nostro” account) with a European bank. The Indian bank can say part of of my money in the Nostro account is owned by Deepak Shenoy, but the money stays in the European bank.

When you do a SWIFT Transaction in dollars – say a Reddy selling medicines to Boris, then Reddy’s bank in India will have to receive USD from Boris.

  • Boris’s bank – a Russian bank – will have a “nostro” account with a US bank (say BNY Mellon).
  • Reddy’s bank – an Indian bank – will have its “nostro” account with say JP Morgan bank
  • Boris will tell his Russian bank to send money to Reddy
  • Boris’s bank will tell BNY Mellon through SWIFT – dude, can you please take money from my account and transfer to Reddy’s bank’s account with JP Morgan?
  • Of course BNY will ask why, and will want to know the transaction details like what’s being sold etc. The US banks are aware of all such trade through the SWIFT system, including which vessel is being used to transport the goods!
  • Once everyone’s happy (JPM, BNY included) then the money will be transferred.

In reality, there are many steps even in advance. A letter of credit can also be created in the SWIFT system that ensures everyone gets paid, so the US banks may be aware of the transaction even when the order is placed, not just at the time of payment.

If you remove the Russian banks from the SWIFT system, you essentially disallow them from using SWIFT to initiate a transfer. The US banks may then totally refuse to do any transaction on the Nostro accounts of these Russian banks. Which means Boris can’t pay Reddy in USD.

What can Boris do? The simplest way is for Boris’s Russian bank to have an account with an Indian bank (say SBI) where Boris can pay in equivalent rupees. Boris will give them money in rubles, which Boris’s bank can then pay equivalent rupees from their Indian bank account to Reddy. What is “equivalent”? Let’s say the Rupee quotes 12 INR to Chinese Yuan and Ruble quotes 15 Rubles to a Yuan, then the cross-quote is Rs. 1.25 to one Ruble.

But this is a painful process for every country that Russia trades with – some people will have money in INR, some in Chinese Yuan, and then in other currencies; but with the SWIFT system gone, the banks have to use a different system to trade.

There is a worldwide standard called ISO 20022 which can be used, but building a new system for that will take time. Meanwhile, there is a Chinese payment system called CIPS (Cross-Border Interbank Payment System) which already has ISO 20022 implemented. Russia could go there (and has significant trade with China).

India, too, may have to move its banks to also register with CIPS, if they are to trade with Russia. And indeed, with China also. While CIPS is in Chinese RMB as a currency, it would be useful for India to have its own system too based on the INR.

The opportunity for using the INR: CBDC

India’s too small right now, but it’s a deficit country (we import more than we export, for the most part). Now assume there are only two countries in the world, and A exports more than it imports from B. If B has to pay A, then can it use A’s currency? Where will it get A’s currency from? Answer: It cannot. So it will pay in its own currency. If there are more than two countries they will pay in the currency of a third country both trust.

In a trade setup, it’s best to trade in the currency of a country that has a deficit. Among India, China, Russia, Brazil, Indonesia and South Africa, India and Brazil are the only large deficit countries.

So if India were to trade with Russia, since we are net importers from Russia, we should pay in INR. But since INR isn’t that very useful, everyone uses a third party currency like USD, EUR etc.

But with SWIFT gone, trades between Russia and India will eventually have to be bilateral. The simplest way is to have Russian banks open accounts with an Indian bank.

The opportunity: Russian banks may consider the Indian banks too risky. Therefore we should allow them to open accounts directly with the RBI using India’s proposed CBDC (Central Bank Digital Currency). This will allow Russian banks to own INR. (See our podcast on the CBDC and why we think it’s interesting)

Further, what can Russia do with the excess INR it will own? Let’s say they want to import something through Dubai. The Dubai company is happy to accept INR. If the Dubai bank were to have an INR account in India (CBDC/RBI): Russia’s bank could transfer INR to a Dubai bank’s account. This is, in effect, Capital Account Convertibility. It’s time to move to that.

Eventually such an operation will work to fund India’s debt, since having excess INR is a waste of effort for any bank and they will need to keep that money in some kind of INR based bond or such. (Safest INR bond is a government bond)

For all of this, we need to change our rules to allow foreigners to buy short term bonds without limitation, allow simple and easy transfers, and to have a legal backing that allows foreign banks to own the rupee (dilute FEMA, make the INR fully convertible etc.) But we’ve argued that at Capitalmind for a decade now.

Note: This will take at least a decade, and will require India to invite all countries (not just Russia) to participate. It may not happen easily but it can hope to be one more country, like Japan or the UK, whose currency is used for trade. If this happens, even in a small way, it opens up so many opportunities later. But it’s best to start now.

This Breakdown of Trust: Taking over central bank reserves

Central banks keep reserves in different currencies. As discussed in the SWIFT section, they have a bank account in the country of the currency of choice (USD/EUR etc) and have balances there. How are reserves built?

  • Say someone, let’s call him Rambo, wants to invest US $1000 in India
  • He tells his bank (JP Morgan) that he wants to convert USD to INR
  • In the rupee trading market in India, JP Morgan says I want rupees for $1000.
  • RBI looks carefully and says, hello, I’d like that $1000, for my “reserves”.
  • JP Morgan says fine, RBI, who’s your US bank?
  • RBI says, BNY Mellon.
  • So JP Morgan says here, I’ve transferred USD 1000 to RBI’s BNY Mellon account.
  • RBI says, I got it, here’s INR 1000*75 (whatever rate was negotiated) in the JP Morgan’s India account in rupees. RBI just prints the rupee and transfers to the JP Morgan account in the RBI.
  • Rambo then uses that money to buys some Indian shares because even a strong man’s gonna retire someday.

RBI plays the role of absorbing dollars coming in, otherwise the rupee would appreciate wildly if lots of people came in to invest (more demand for the rupee than supply) and when enough people want to redeem and take money out in USD, RBI will then sell the dollars it owns and take back the rupees.

Now why would RBI build reserves? Because if India wants to buy oil or other such things, RBI can deliver USD against rupees to the bankers of importers like BPCL, who will then pay for oil using these dollars. India’s built up some $600 billion USD worth of reserves, but not all of them are USD. Some are Euro, some Japanese Yen and so on. A small portion is in Gold.

RBI builds reserves when it gets outside money for non-trade reasons (we are a net importer):

  • Investment into Indian listed stocks (Foreign Portfolio Investment) or new businesses (Foreign Direct Investment)
  • NRIs depositing money into Indian banks for their higher INR based gains
  • Remittances to family from workers abroad
  • Indian companies borrowing money in USD

Russia’s central bank too, has such reserves, about $600 billion worth (as much as India). Russia generates the reserves because it is a massive exporter and generates a surplus (more exports than imports) of nearly $80 to $100 billion per year. A good portion of this surplus is in gold – nearly $280 billion worth. So there’s about $320 billion in other currencies (USD, EUR and probably JPY, CNY etc).

The US and Europe have decided to freeze the central bank reserves of Russia which is in USD and EUR. This is horrible, because now there’s no way to defend the Ruble for a person inside Russia looking to exit the country and exchange Rubles for Dollars. The central bank cannot participate. Russia isn’t allowing anything of the sort right now. No one can exit investments in the country easily. Which is exactly why Visa, Paypal or other such systems cannot exist meaningfully, and no cross border trade is easily possible.

But this has a sinister problem: How can a country freeze another country’s reserves? Isn’t that stealing? (Answer: Not if the west does it)

America has done this twice already with impunity. Iran’s reserves in USD have been frozen. And then, when they left Afghanistan, they decided that the Taliban were bad people and so, they just cancelled $3.5 billion worth of reserves of the Afghan central bank. You didn’t hear about this? Because America did it, it isn’t stealing. So they’re trying to do this with Russia.

Only, this is a bad idea because Russia has nukes and even if you have nukes, you don’t steal from a person that also has nukes. It’s just a bad idea, and a bad precedent. This means they can do this even for India, if they decide that India doesn’t do something they want us to do. It is a breach of trust, and India must act to secure its interests. One way to do this would be to transition to gold (waste of effort really), but the better way is to have INR used internationally in a bigger way. China is doing it strongly with the Yuan, and India needs to slowly do this instead of stockpiling reserves.

(For example, RBI has 3 times more USD, when translated to rupees, as the next biggest asset they own – Indian government bonds. In effect, our central bank finances the US deficit more than the Indian deficit)

The point, really, is that trust is no longer a given in the international central bank reserve currency sphere, and India being what it is, needs to start thinking beyond the USD.

What’s our exposure to the war-torn countries?

Here charts of our exposure. We import lots of oil from Russia, nearly $4.5bn of it. In fact, we run a deficit of over $5 bn to Russia.

For Ukraine, it’s just a little smaller. Our biggest import is Sunflower oil ($1.8 bn) and we run a massive #3bn deficit with them, exporting hardly $500 million to them.
In general the impact points are:
  • We will have disruptions in Sunflower oil production since we import so much from Ukraine (which will be in trouble right now). That would affect products like Saffola (Marico) and so on.
  • We will also have disruptions in crude oil supply if we cannot import from Russia, but it appears this is a boon for India as other countries don’t want to import from Russia so we get the oil at cheaper prices.
  • We do import rough diamonds from Russia, and export a bunch of pharma to both Russia and Ukraine. We should expect some disruptions there in some way.


The world itself has exposure to Russia and Ukraine in different ways (and India is very tiny, in that context).

Russia Ukraine Trade

India could take over some of the slack here. For example, Russia/Ukraine has about 36% of global iron and steel exports and about 25% of global wheat exports – India does have some surplus in both, and we can benefit from this if it persists.

It won’t last long: we should just work with Russia?

But increasingly, it appears that the situation may not create a hole for too long. Russia is a big market for the west, and if it shuts down gas supply to Europe, there will be a massive recession, especially in Germany which has nearly 1/3rd of energy dependence on Russian oil. The US imports Uranium from Russia and will continue to do so. Large US and European brands sell significant quantities of products in Russia (Mercedes, Audi, Adidas, luxury designer brands etc.) and closing that output will hurt bottom-lines heavily even longer term.

What’s the opportunity for India?

Trade with Russia: We are likely to continue trade with them, and sanctions are unlikely to apply. Given our trade deficit is largely the oil we import from them, we should be able to balance that a little more to substitute some of the other products they currently get from other countries. In fact trading in INR with Russia may be an interesting intermediate step, but it is more likely that we use other currencies (Chinese Yuan or such) to mark the trades. Meaning, we will decide the price in USD or Yuan (in which both RUB and INR can be quoted) and then actually keep the rupee equivalent in a Russian account with either the RBI (CBDC) or with an Indian bank.

Trade with Ukraine: Currently there is a lot of anti-India sentiment in Ukraine because India didn’t censure Russia. Therefore India will need to either reduce or diversify what it does import: Sunflower oil, Fertilizers etc. or build more capacity domestically. India imports nearly 70% of its sunflower oil needs from Ukraine, and we should expect hiccups there. However, on the services side, Ukraine is a great country for software developers so hopefully there is potential for Indian IT companies to outsource some requirements there as well.

Inflation in the world: Does this get scary or not?

For a while, crude prices touched $130 and now they have receded to under $100 now. But prices of a lot of things have been going up regardless, even before this crisis. We have to differentiate between inflation based on too much demand and inflation based on supply constraints. Demand based inflation can be curbed purely by interest rates – make it expensive to run a business and demand will cool.

Supply based inflation – where the demand is normal but supply has fallen – is usually temporary. Meaning, whatever that supply constraint is, will go away when supply returns. Supply will return either by the normal cycle (vegetables are cheaper in winter and more expensive in summer) or by new suppliers coming in (if steel prices go up because some big guy shut down a plant, others expand their capacity and bring more steel in eventually).

The crude shock is a supply shock, and replacements are currently hard to find. Saudi and UAE are not keen on increasing supply (knowing that Russia’s gas and oil is still being sold). Iran and Venezuela are sanctioned and can’t do much. The US has a ton of oil but doesn’t want it to be taken out of the ground for strange reasons. There’s other fear as well, like in Wheat. India, the US and Europe have reasonable wheat reserves to supply the world if the prices remain high, and then Russia will eventually return.

Here, interest rates may not help too much, since interest rates curb demand, and hurt supply coming back too. But rates can be used to dampen demand if supply cannot come back soon, to reduce demand to a point where it can meet the lower supply. Our feeling here is: inflation is too big an issue already even before this shock. If the sanctions and war cause too much inflation, the west will work hard to find a solution. They simply cannot handle high interest rates with their insane fiscal deficits and high public debt. (Most developed economies have more than 100% of their GDP as government debt)

The US raised rates a few days back, pushing for 7 more rate raises in the year, which should take rates to 2% short term rates within a year. The minute this causes a recession of any sort, there will be a reversal of policy, in our opinion, but we must be ready for higher rates in the west. In India, rates have already gone up and we might see some rate rise by RBI marginally.

Impact for India: Our rates are high enough already, and inflation has yet to hurt India meaningfully. If India should seize the opportunity to be a bigger player in the world, it has to be by pushing for more domestic output and substitution of imports. This will require that Indian interest rates be relatively low, and push for higher credit growth.  Meaning: don’t raise rates like crazy, and don’t let the rupee slide too much.

Bracing for inevitable defaults in the credit markets

There are issues brewing.

  • There are 500 airplanes in Russia all leased from foreign lessors, many from EU/US locations. Russian airlines can’t easily pay (SWIFT ban) and lessors can’t easily repossess. (How do you do that – Russia doesn’t allow EU/US planes to fly, so if the lessors cancel the leases, they can’t fly the planes out because they become European/US.) This is a fairly large sum of money, so at some point, the lessors will default on their own loans, which they took to finance the planes.
  • Hedge and Mutual funds in the world that bought Russian stocks can now not sell them at all. If they get redemptions, they cannot return the money. This creates issues – ERUS, an iShares Russian Market ETF, has halted operations. Russia’s stock market is closed and no foreign investor is allowed to sell shares. Now if anyone had placed such shares under collateral for a loan, there’s going to be trouble since you can’t redeem them.
  • Debt issued by Russia and its companies, which is denominated in USD, will see some issues too. If the SWIFT ban continues, that is. If they can’t pay, there will be defaults. Remember LTCM = Long Term Capital Management? It was a huge massive hedge fund that imploded because (checks notes) of a default by Russia in 1998. It’s not even like I have to work it out – it’s even happened before. Note: Russia says it’s paid a recent interest payment, even though their processor, Citibank, hasn’t confirmed it has been able to pay all bondholders yet. There’s an exemption that allows Russia’s central bank to pay, till 25 May, but that doesn’t apply to other Russian corporations.
  • Credit markets will have issues with lack of liquidity since about $300-500 billion of money is now locked. Think of a company that has issued bonds, and some big Russian people have bought those bonds. When it’s time to roll them over, they have to pay the Russian people back, and the assumption is that the Russian people will buy another bond of a later maturity. Now those Russian people have been sanctioned, and the money cannot be rolled over. Which could result in even good, non-Russian companies getting hit.

All of these issues can hurt credit market liquidity quickly, and much about the world system

We have to watch carefully for these situations or more to emerge. Our experience is that the problems first get visible in the Credit Markets, before they come to equity. And while there is some calm right now, things can change very fast.

In Summary: What is the opportunity for India?

Here’s a summary:

  • Don’t trust the west: Sanctions can be illogical and cripple you. Specifically a ban on SWIFT or a sequestering of central bank reserves. Therefore push for the internationalization of the rupee, through a Central Bank Digital Currency.
  • Increase trade with Russia to provide their people with the things that they can no longer get from other countries. Cross pay with the oil we import from them.
  • Allow Russian (and other country) banks to hold INR accounts and use that INR to pay other countries, and participate in Chinese CIPS as well.
  • World inflation will raise interest rates and money worldwide. But India needs relatively low rates to keep its economy strong, so we shouldn’t overreact on rates.
  • Watch out for credit market defaults of Russia, it’s corporations or companies who trade with it. There could be contagion here. This is more a threat than an opportunity, but in all such crises there will be avenues that open up.

What should Indian investors do?

Don’t do too much, but wait and watch for a few things:

  • Credit market defaults: this can hit markets worldwide and fast.
  • Massive rise of prices in food: while this may be temporary, the governments will be forced to act, if this happens.
  • A settlement between Russia and Ukraine: This is good for markets, and sanctions will eventually be watered down for Russia.
  • Increase in hostilities: We don’t like this, but if more countries get directly involved in the war, it will prolong the agony.
  • Recessions in Europe: Europe is anyhow in bad shape, and this situation will make it worse. Other than Germany, most countries don’t inspire fiscal confidence. The advent of a recession based on inflationary pressure can result in equity and debt market turmoil. This will however take a lot of time, if it happens.
  • India’s resurgence: Much about a weaker Europe and a weaker Russia points to a stronger someone-else. That someone-else, in size, is only India, China and the US. Only two of these countries can be invested into. I will stop there.
  • Earnings: we should see lower earnings because of demand cuts and supply issues in the world, and the results in April will show us how much damage there is. This could impact some stocks, but the market has already punished a lot of overvaluation, and very heavily.

The idea of selling everything now isn’t great, but strategies like Momentum may have a cash build-up because of lack of opportunities. In that sense, we need some dry powder (we have cash in our Focused portfolio as well). We suggest that you stay aware of the news, stay aware of how much propaganda there is, and don’t panic.

In terms of “should I sell my neighbour’s house and buy stocks?” (an inside joke in Capitalmind Slack) – the answer is “not yet, but don’t invade them either”.


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