RBI talks about geopolitical ripple effects on Indian economy

In recent years, geopolitical tensions have emerged as a significant global concern, profoundly influencing economies worldwide. Geopolitics plays a pivotal role in shaping trade policies, currency fluctuations, supply chains, investment flows, resource accessibility, and technological advancements. The global economic landscape is undergoing a transformative shift, marked by increasing protectionism, restrictions on technology transfers, the formation of geopolitical blocs, de-globalisation, and a resurgence of mercantilism (accumulating wealth through trade surpluses).

India is no exception to the influence of geopolitics. The Indian economy, deeply integrated into the global ecosystem, is particularly vulnerable to fluctuations in the geopolitical environment. For instance, the appreciation of the US dollar often triggers capital outflows, while tariff hikes adversely impact export performance. To mitigate these risks and understand their implications, it is essential to measure and analyse the impact of geopolitical tensions on the economy.

Understanding India’s Geopolitical Risk Index (GPRI)

The Reserve Bank of India’s (RBI) recent bulletin, titled “Geopolitical Risk and Trade and Capital Flows to India”, examines the influence of geopolitical tensions on India through the Geopolitical Risk Index (GPRI). This bulletin, authored by former RBI Deputy Governor Michael Patra alongside researchers Harshita Keshan, Sheshadri Banerjee, and Harendra Kumar Behara, uses geopolitical news events to assess India’s domestic and global response to such risks.

Historical data highlights spikes in India’s GPRI during events such as the Kargil War (1999), the Kashmir insurgency (1990), the Gujarat riots (2002), and the Mumbai attacks (2008). Notably, a strong correlation between India’s GPRI and the global GPRI has been observed since 2014, indicating India’s increasing connectivity to global geopolitical dynamics.

Economic impact of high GPRI

A heightened GPRI negatively affects India’s economy, leading to:

• Currency depreciation: A depreciating rupee as foreign investors convert rupees into dollars to mitigate risk exposure.
• Decline in capital inflows: Reduced foreign investment as geopolitical risks make India a less attractive destination.
• Trade disruptions: Contraction in trade volumes and adverse shifts in trade terms due to higher costs and disrupted supply chains.

Increased geopolitical tensions also lead to rearranged trade routes, inefficient resource allocation, and higher export prices, which collectively diminish export competitiveness. The recovery of capital flows tends to be quicker compared to trade, which usually requires 6–7 quarters to rebound fully.

Quantitatively, a one standard deviation rise in domestic GPRI results in a 0.2 percentage point decline in capital flows and a 0.9 percentage point reduction in trade volumes. Similarly, global GPRI has a more pronounced impact, with a one standard deviation rise causing a 0.3 percentage point decline in capital flows and a 1.0 percentage point contraction in trade volumes.

Characteristics of geopolitical risks

Unlike conventional economic risks, geopolitical risks are persistent, long-lasting, and harder to mitigate. Domestic geopolitical risks undermine India’s export competitiveness and disrupt supply chains, while global risks hinder capital flows and trade levels due to stricter policies and cautious foreign investment strategies.

Strategies to address GPRI

To counter the impact of geopolitical risks, India must adopt a multifaceted approach:

1. Trade diversification: Reducing dependence on a few trade partners by expanding trade sources.
2. Bilateral and multilateral agreements: Strengthening trade relations through bilateral swap agreements and partnerships with institutions like the World Bank and IMF.
3. Infrastructure development: Enhancing domestic infrastructure to ensure efficient and secure trade.
4. Financial buffers: Creating robust financial safeguards to cushion the economy against geopolitical shocks.

By fostering diversified trade partnerships, improving infrastructure, and adopting precautionary measures, India can build resilience against rising geopolitical challenges and secure its economic stability amidst global uncertainties.