Iran and India : Testing times

For the global economy, the Strait of Hormuz is less a waterway and more a jugular vein. As the conflict in West Asia intensifies, most nations are monitoring developments with bated breath, fearing a total blockade. Yet, in the wood-paneled corridors of New Delhi’s North Block, the mood is one of wary relief rather than panic. Thanks to a diplomatic coup that has effectively decoupled India from the regional shipping blockade, we have been able to secure a Hormuz Pass. But while the physical shortage of oil and gas has been averted, another economic threat poses a challenge.

Diplomacy as a Shield

In a world of hardening blocs, India’s strategic autonomy has paid yet another dividend. Earlier this month, Tehran officially designated us a friendly nation, granting our vessels safe passage through the world’s most volatile chokepoint. While tankers from other jurisdictions wait indefinitely or take other longer and unviable routes where possible, Indian-flagged vessels are steaming through the Strait with Iranian blessing.

This move has shifted the nature of the crisis for Prime Minister Modi’s government. India has successfully sidestepped a 2020-style volume shock—the kind of existential shortage that threatens to shutter factories and halt transport, for want of critical raw material and energy supplies. By ensuring that oil and liquefied natural gas (LNG) continue to flow, we have prevented a nonlinear economic fallout. However, in the cold logic of global markets, safe does not mean cheap.

Protection isn’t a panacea

The problem of availability has thus been replaced by a problem of cost. Even with a general all clear from Tehran, the arithmetic of war is taxing. Maritime insurance rates for the region have surged four- to six-fold. Shipping giants have slapped emergency freight increases of thousands of dollars per container on Gulf routes.

The macroeconomic cost is stacking up. Every $10 increase in the price of crude oil typically drags down our GDP by 0.4%. With Brent crude now stubbornly anchored above $100 a barrel due to the geopolitical risk premium, growth projections are being trimmed. Analysts expect corporate earnings to be shaved by upto 2% per quarter as rising input costs bite. And the longer the disruption at the Strait of Hormuz lasts, the longer it will take for supply chains to normalise as for every one month of disruption it usually takes three months to regularise.

Beyond the oil bill, two hidden complications have arisen. First, the cost of LNG-based urea has spiked by 50%, materially increasing India’s fertilizer subsidy bill just as the Kharif sowing season nears. Second, the regional slowdown is threatening remittances—a key pillar of India’s foreign-exchange stability—of which approximately 40% typically flow from the Gulf. Therefore, the Indian Rupee, the economy’s key sensitivity currently, remains under pressure for these and other reasons (the subject of a previous column).

Calibrating the Response

The government’s toolkit is centrally focused on absorption. To protect the external sector, the RELIEF (Resilience & Logistics Intervention for Export Facilitation) scheme has been rolled out, offering 95% risk coverage to exporters drowning in war-risk premiums.

The fiscal policy measure of lowering fuel excise duties, charged to the oil marketing companies, to offset the global oil price surge, prioritises social stability over budgetary conservatism. However, the cost is a 0.4% of GDP revenue shortfall, making this year’s 4.3% fiscal deficit target quite difficult to achieve and narrowing the government’s headroom for future infrastructure spending. And most importantly, this may be the opportunity to let the market decide retail fuel prices, forcing consumers to feel the pinch to naturally reduce oil demand. Meanwhile, the crisis has exposed a key structural shortcoming—India’s strategic petroleum and gas reserves remain dangerously low compared to our Asian peers and substantially increasing these must be the most urgent takeaway from this conflict.

On the domestic front, the Reserve Bank of India (RBI) faces a delicate balancing act. It must decide whether to use its $700 billion forex reserve warchest to defend the Rupee or allow an orderly depreciation to keep exports competitive. Market watchers are leaning toward the latter, paired with a potential interest rate hike to stem capital outflows.

The New Normal

India has proven that clever diplomacy can keep the tankers moving when the rest of the world is at a standstill. But as the conflict drags on, the limits of this strategy are becoming clear. We may have bypassed the blockade, but we cannot ignore the cost of this conflict. For now, our economy can absorb the stress, but it is doing so at the cost of a rising fiscal deficit and a weakening currency. Fortunately, the roof mending through various economic reforms over the last few years puts us in a position to be able to weather this storm. As the saying goes “Do not pray for an easy life, pray for the strength to endure a difficult one”.

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