What Could The Israel-Iran Imbroglio Mean For Us?

Just at the time when it did seem that the world economy was getting into some sort of nervous equilibrium against the background of the tariff threat held out by the USA, the war in West Asia has upset the applecart. Crude oil prices have started increasing sharply, with Brent going at $75/bbl and poised to go further, depending on the state of the war. In this context, it is worth examining how India can be affected, as the impressionist view is that there could be higher inflation and possible pressure on the budget.

The Israel-Iran war is more like the Israel-Hamas war and not the Russia-Ukraine war. The reason is that in the case of the Ukraine war, Russia was a major supplier of oil to the world and hence tilted the scales on the energy front, as several countries were dependent on oil and gas from Russia. In the case of Israel-Hamas, neither had much to do with energy resources, and the only fear was that other nations producing oil could join the war, which did not happen. However, in the present situation, Iran is a producer of oil with a share of around 4%. But, there is an embargo on buying anything formally from Iran, which has been imposed by the West. Hence, the oil exports from Iran are limited, and that too in a limited manner to China. Therefore, there is unlikely to be a demand-supply imbalance on account of this war.

This factor is critical because when a nation controls a significant supply of a product, any decline in exports can affect the demand-supply balance, as it is not possible for others to supply more given the turnaround time involved. With Iran virtually out of the supply chain, the physical impact would not be there. However, the prospect of any other country with considerable oil resources supporting Iran directly can impact these flows. Presently, it does not appear that the war is likely to spread and will be localised. Hence, the impact as such will be muted.

Coming to how India can be affected by this war getting prolonged, the following can be conjectured: First, the price of oil has gone up for sure but should mean revert once the war ends. Here it is hard to say when the battle will be done, as the Ukraine war has been on for almost 30 months. But even in that case, prices did correct after three months or so, and hence, the effect was not long-lasting. That said, India has been importing from Russia a little over 2/3 of its requirements at a discounted price. Therefore, the full cost will not have to be borne, as the imported cost will tend to be lower than the global price.

Second, even in case crude oil prices remain higher at the level of $70 or $80 plus per barrel, consumer inflation may not be affected. The reason is that the fuel prices at the retail end in the country have remained unchanged through different cycles. Higher global prices have been absorbed by both the government and oil marketing companies. At the same time, the lower price benefit has not gone to the consumer but is shared between the government and OMCs. Hence, this policy has turned out to be prudent and will buffer against any price rise.

At the wholesale level, prices will increase, and the WPI index will show an increase but will not matter from the point of view of monetary policy. The WPI includes products like motor spirit, high-speed diesel, kerosene, naphtha, and aviation turbine fuel, among others. These prices would tend to increase and can have secondary effects on users of these products other than the retail end. The ATF price can have a bearing on airfares and freight rates, provided it becomes more permanent in nature.

Third, higher crude oil prices will affect the import bill, and given that the US tariff regime will be working against the growth in exports, there will be some pressure on the trade front. On the positive side, higher prices of crude will also mean higher realisations on the export of petro products. The net result could still mean some pressure on the rupee, which will mean more oversight from the RBI to control volatility. But any impact of a weaker rupee will work in favour of pushing exports at the margin, as India competes with other Asian countries in areas such as textiles, chemicals, precious stones, and electronics, among others.

Fourth, the impact on the budget will be quite insignificant. This is so because ever since the prices of petrol and diesel were decontrolled, there is a limited subsidy being given by the government. Presently, it is largely for LPG where prices are being revised periodically. Therefore, the pressure on the subsidy bill on petro products would not be there. The fertiliser subsidy can increase if global prices go up in the case of natural gas.

Fifth, one area which would be a concern will be in the logistics space, as shipping and insurance costs could increase on this score. There are possibilities of the Strait of Hormuz being closed by Iran to some degree, which will increase the time involved as well as the cost for moving goods, especially oil. This is something that can affect the entire world and cannot be ignored.

On the whole, the direct impact of the war could be limited, though the government and the RBI need to be watchful on the economic side, as markets can be whimsical. So far, it has been business as usual, but one can never tell.

The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.

Published on: Monday, June 23, 2025, 07:46 AM IST