How the war waged by Russia in Ukraine hurt Nepal's economy, which is already struggling to find its footing.

Russia is fighting a war with Ukraine in Europe. But, the war is also having ripple effects in faraway Nepal.

None of these countries are major trading partners for Nepal. Nor is Nepal involved in the war. However, it is not immune to the global supply chain disruption caused by the Russia-Ukraine war and its economic fallout.

It is still unclear whether and how the turbulence in Europe will impact the performance of Nepal’s economy. However, individuals and households are already feeling the pinch as prices of oil and other commodities have started rising steeply.

War-fueled prices
The ongoing war between Russia and Ukraine is blamed as the major culprit behind the recent surge in fuel prices not only in Nepal but all over the world. Nepal completely relies on imports of fuel and other petroleum products from India, which also depends largely on Russia to meet its demand for petroleum products.

The oil market is heading for the biggest supply crisis in decades owing to the supply chain disruption and economic sanctions imposed against Russia by Western countries, led by the US.

According to the International Energy Agency, Russia is the world's largest exporter of oil to global markets and the second-largest crude oil exporter behind Saudi Arabia.

In line with the steep rise in crude oil prices in the international market, the price of petroleum products in Nepal has also gone up significantly in recent days.

Oil prices continue to soar in the international market. At one point in the first week of March, the Brent crude price-a major benchmark price for purchases of oil worldwide-soared above USD 130, the highest since 2008. With the cost of oil imports from India continuing to surge, Nepal Oil Corporation (NOC)—the state-run oil monopoly—has been raising the price of petroleum products in the domestic market.

Petrol's price in the domestic market has now reached a record high of Rs 155 per liter. So has the price of diesel and kerosene. Due to a fear of public backlash, the NOC has not dared to raise the price of cooking gas. The loss-making state corporation will not be able to resist the pressure for a long time or stop the price rise.

What's worse is that oil prices in the global market are poised to go up further in the days to come. There are projections that the oil price could reach USD 200 per barrel. While raising its price forecast to USD 135 per barrel, Goldman Sachs recently warned that the world could face one of the largest energy supply shocks ever. Similarly, Barclays also said that the disruption of Russian supplies could push oil prices above USD 200 per barrel in 2022.

With no immediate end in sight to this war, there is less chance of a significant correction in oil prices. At least for some months, the high cost of petroleum products will continue to hurt Nepali consumers.

Threat to price stability
The oil supply shock has not only inflicted the pain of a higher energy price alone. It also leads to higher inflation. Higher oil prices also raise the cost of transportation. When the cost of transportation goes up, it also raises the price of goods and other supplies. When the cost of production goes up, it is passed on to the consumers through the added prices. And that is already happening. Even before the Russia-Ukraine war, the oil price was on an increasing trend, contributing to a price rise. The prices of most of the goods and commodities in the market have already gone up. From construction materials to food items, the price of goods and commodities has been climbing.

Nepal also imports some commodities from Ukraine and Russia. Nepal's total import from Ukraine in the first seven months of the current fiscal year (2021/22) was Rs 14.42 billion, according to Department of Customs data. On the other hand, it exported goods and commodities worth Rs 1.58 million in the same period. Imports from  Russia in the corresponding period stood at Rs 4.31 billion, while exports remained at Rs 151.1 million. Cereals, edible oil, and oil seeds are some of the major imports from Ukraine that are going to be hit. The price of edible oil has also gone up significantly in the market in recent days. However, it would not be the imports and exports that Nepal directly makes to these warring countries that would be hit. As the supply chain gets disrupted and shipments are suspended, Nepal will also grapple with the crunch of the price rise of many commodities and goods that the world will face.

The supply disruption caused by the war in Ukraine is accelerating that trend, giving policymakers and governments around the world a nightmare to deal with as they struggle to maintain price stability. Nepal must not become an exception to that trend. Though inflation as measured by the consumer price index (CPI) was largely below the target set by the Nepal Rastra Bank (NRB), it was significantly higher than it had been in recent years.

According to the most recent Nepal Rastra Bank (NRB) data, inflation was 5.97% in mid-February, up from 2.7% a year ago. While the inflation level in mid February does not represent the situation after the Russian invasion of Ukraine that began on February 24, it still indicates the high inflation trajectory set off partly due to the rising cost of energy. Import costs are also going to increase in the days to come. Most of the raw materials consumed by factories in Nepal are going up, putting pressure on industries to raise their prices of finished goods in line with the spike in production costs.

Policymakers are worried that the soaring oil prices and supply disruption caused by the war in Ukraine could threaten price stability.

External sector pressure
Nepal has another reason to worry about. The country's trade deficit was already widening at an alarming rate. Disruption of the supply chain of trade, which has raised the cost of trade, will exacerbate the deficit. Since Nepal's total imports are far bigger than exports, the trade deficit is expected to grow further in the days to come. According to the data of the Department of Customs, Nepal's trade deficit rose to Rs 1,015 billion in the first seven months of the current fiscal year 2021/22 from Rs 733.73 billion in the corresponding period of the last fiscal year 2020/21. This will put pressure on the country's balance of payments, which has been a cause of concern for policymakers in recent months. According to the NRB, the balance of payments remained at a deficit of Rs 247.03 billion in mid February.

The depreciation of the domestic currency vis-à-vis the US dollar is another factor that could worsen Nepal's trade deficit. The US Federal Reserve has recently hiked its interest rate to counter the economic risks posed by higher inflation and the war in Ukraine. The decision is expected to push up the value of the US dollar. The stronger US dollar is anathema to economies like Nepal's, as it makes imports more expensive. Higher import bills will not only put further pressure on the balance of payment but also risk draining the foreign currency reserve of the country.

As energy supplies are disrupted, the soaring price has even impacted Nepal's electricity costs. The Nepal Electricity Authority (NEA)—the power utility—imports electricity from India during the dry season to meet the energy demands in the country. As the cost of the demand for energy has gone up in the Indian market, the cost of per unit electricity has reached up to Rs 32 per unit, according to NEA Managing Director Kulman Ghising.

Headwinds to Economic Recovery
While it is too early to predict the impact on growth, the escalation of the war is likely to slow the country's economic recovery. The International Monetary Fund (IMF) has already said that it expects to lower the global growth forecast due to the war in Ukraine and massive sanctions against Russia. If the war prolongs or deepens in Ukraine, the effect could be broader. Remittance inflow, foreign investment, tourist flow, and trade, among other various aspects of the economy, could suffer. This will also have an impact on Nepal's economy, which is still struggling to find its footing.