India is closely monitoring the increasing tension in West Asia. PMO and key ministries are reviewing the situation. If officials are to be believed, there are concerns that a prolonged conflict could put pressure on the economy through higher oil prices, larger deficits and weak remittance flows. Senior officials on Sunday took stock of the rapidly changing situation and its possible impact on India. A senior government official said in a media report that we are closely monitoring the situation. After returning from a two-day tour of the states, Prime Minister Narendra Modi also chaired a meeting of the Cabinet Committee on Security to take stock of the situation.
Israel and the US launched a joint strike on Iran on Saturday morning, which included attacks on “dozens of military targets” as part of a larger, coordinated and joint attack that killed Iran’s Supreme Commander Ayatollah Ali Khamenei. Due to the possibility of prolonged turmoil in the Gulf, economists fear increased volatility in the stock and energy markets as well as the rupee. Let us also tell you what the experts have to say about this.
How will it affect the rupee?
Sonal Verma, Nomura’s managing director and chief economist for India and Asia (except Japan), said in the ET report that India is one of the economies in Asia on which the impact of high oil prices is more visible. Anubhuti Sahay, head of India Economic Research at Standard Chartered Bank, said in the same report that the impact on India will be through an indirect channel — increase in oil prices and risk-off sentiment. He said that this may have an impact on the rupee, although its weakness can be managed for now. Reserve Bank of India (RBI) has considerable foreign exchange reserves.
Sahay told ET that a big risk to keep an eye on is how quickly the Middle East stabilises, as any prolonged conflict will have an impact on oil prices and growth-inflation dynamics in India. Verma said India imports more than 85 percent of its domestic oil needs, and about half of its crude oil imports currently pass through the Strait of Hormuz. The macro impact will depend on how much oil prices rise, and for how long the rise lasts.
Increase in crude oil prices
Due to large scale outflow of foreign funds, the rupee fell by 17 paise to 91.08 against the dollar on Friday. In the last one month, crude oil prices have increased from approximately $65 per barrel to $82 per barrel. India imports 88-89 percent of its crude oil requirement. Nomura’s Verma said that the impact of higher oil prices on inflation should be less for now, as there is little hope of oil marketing companies increasing pump prices, hence growth should also get good support. He said that although the current account deficit is manageable at ~1 per cent of GDP, the main risk comes from pressure on the capital account due to foreign investment outflows, which could worsen due to geopolitical uncertainty. Every 10 percent increase in oil price has an impact of 0.4 percent on GDP.
How much will it affect the economy?
Verma further said that we think this is a short-term risk, but it can be managed, and India’s medium-term outlook remains positive. ICRA Chief Economist Aditi Nair said that we are keeping an eye on the changing developments and what impact this uncertainty will have on Indian macros. For now, the strong domestic outlook provides relief. He said how long and wide this (Iran situation) plays out will impact India’s macros, including the impact of fuel prices on inflation and things like the twin deficits, as well as remittances. Retail inflation in January was 2.75 percent. Bank of Baroda Chief Economist Madan Sabnavis said that bond yields are unlikely to be affected, but rupee volatility may increase.