India braces for economic strain as West Asia conflict escalates. Oil prices, trade and jobs at risk.

A vulnerable point for the Indian economy, which imports nearly 85% of its crude oil requirement, is energy security, but experts remained optimistic about global powers stepping in to contain the crisis and limit damage to trade and economy.

With crude oil output of almost three million barrels per day, Iran is a major oil producer and exporter. A fifth of the world’s crude oil supply, and 60% of Indian crude oil supply passes through the Strait of Hormuz.

A conflict in the region could push up oil prices sharply from the present level of about $72 per barrel to a level of $80, said Manoranjan Sharma, chief economist at Infomerics Ratings and former chief economist at Canara Bank. This could worsen India’s trade deficit, current account deficit and fiscal deficit.

The stock market in India could suffer because of the overarching negative sentiment and a discernible element of froth and bubble, Sharma added.

Global GDP and trade growth will be the main casualty, said Devendra Pant, chief economist, India Ratings & Research. The conflict will have an impact not only on India’s current account balance but also on the balance of payment, said Pant, adding that India’s strong foreign exchagne reserve (of over $690 billion as of 20 September) will certainly be helpful.

Exporters believe that if Iran’s ports are attacked, outbound essential commodity supplies could get hit. Iran has several ports given its strategic location between Persian Gulf, the Gulf of Oman, and the Caspian Sea.

“The broader impact on international trade routes would be severe, and disruptions to key shipping lanes could significantly hurt global supply chains," said Vijay Kumar Setia, former president of All India Rice Exporters of India (AIREA) and director of Chaman Lal Setia Exports.

Indian exports could suffer due to this conflict, he said. “Many products pass through Iranian ports, and further hostilities could jeopardise not just the rice trade but also trade in a range of Indian goods. The possibility of increased freight costs amid geopolitical tensions, coupled with the ongoing Red Sea challenges, poses serious risks to Indian exporters, already grappling with rising operational costs," Setia said.

However, experts believe that the situation is not all that bad, as there are mitigating factors as well.

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Silver linings

The West Asia flare-up comes at a time when Opec+ is shifting towards higher production, limiting the upside risk to oil prices, inflation and hence interest rates, said Sachchidanand Shukla, group chief economist at Larsen & Toubro Ltd.

“Iran contributes around 4% of global oil output and Saudi Arabia can also ramp up some production to make up for any shortfall. Moreover, so far, in spite of the West Asian crisis, oil prices have not really moved up on a sustained basis given that major economies—the US, the EU and China have been struggling with lacklustre growth. If the situation is prevented from morphing into a regional war using diplomatic tools, then the disruption to the global economy and trade are likely to be contained," said Shukla.

The Indian basket of crude oil comprising both sour and sweet grades averaged $73.69 in September, down from $78.27 in August and $89.44 in April, according to petroleum ministry data.

The price of Brent crude, a global benchmark, has risen by over $4 a barrel in the last three days. It stood at $75.63 a barrel on Wednesday, up from $73.56 on Tuesday and $71.7 on Monday. But this is lower than the $85.81 per barrel Brent was at a year ago.

West Asia is a key source of oil import for India, but after Russia invaded Ukraine in February 2022, imports from Russia rose sharply due to the huge discounts on offer.

In terms of volume, Russia’s share in India’s oil imports rose significantly from 2% in FY22 to 21.5% in FY23 and over 36% in FY24. In contrast, the share of crude petroleum imports from West Asia decreased from 34% in FY22 to 30.9% in FY23 and to about 23% in FY24.

There are other factors that will determine global commodity prices and flow of capital. Going forward, the US election outcome, the rate of change in the US Federal Reserve’s reaction function and its interest rate trajectory will also shape and determine the pace of recovery in global growth and the direction of risk assets and emerging markets, including India, said Shukla.

Aditya Narayan Mishra, chief executive of CIEL HR Services, a staffing firm, said that for the time being, the attractiveness of the West Asia region may wane and that any returning workforce could pose sociological challenges.

“Their wages and living and working habits are different. The workers save up ₹7 lakh a year and send home the money, which will not be possible if they return to India," said Mishra, pointing to a potential hit on remittances.

The impact will be visible if the crisis lasts longer than a few days, according to Lohit Bhatia, president of workforce management at staffing company Quess Corp. “West Asia absorbs talent from India in the construction, earth moving, and entry-level jobs in the auto-manufacturing industry. However, for a short while, there may be a positive impact in similar sectors in India, where workforce is difficult to get," said Bhatia.

Freight fears

Sharma of Infomerics Ratings believes the capital market, which is sentiment-driven, could take a hit.

Energy prices are slowly increasing, but a drastic surge could follow depending on whether Israel targets Iran's nuclear facilities or its oil refineries, with the latter being a more vulnerable and likely target, explained Ram Singh, professor of international business at the Indian Institute of Foreign Trade and the head of its Centre for Distance and Online Education.

Strategic interests, particularly regarding trade routes through Iran, such as the Chabahar port and access to Central Asia and Russia, are also at risk, said Singh. If the conflict spills over into neighbouring countries, it could result in the closure of the Strait of Hormuz, leading to a global energy crisis, he said, adding that high-value exports such as gems, jewellery, pharmaceuticals, agricultural products, and electronics were also at risk.

Viranchi Shah, president of Indian Drugs Manufacturing Association, too expects logistics costs to go up. However, India’s volume of pharmaceutical trade with Iran and Israel are limited, said Shah.

A series of attacks by Iran-backed Houthi rebels in Yemen following the outbreak of the Israel-Hamas war last October had earlier sparked fears of global supply chain disruptions. As a result, leading global shippers rerouted their vessels bound for the Red Sea for safety reasons, increasing costs and time for the movement of goods through freighters.

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These disruptions, coupled with a global economic slowdown, likely led to a less than 0.8% increase in global merchandise trade volumes in 2023, falling short of the WTO projection.

“The Israel-Hamas war, which erupted in October 2023, has now extended to Lebanon, Syria, and Iran and is indirectly impacting Jordan. Key regional players like Saudi Arabia, the UAE, Kuwait, and Qatar have thus far remained uninvolved in the conflict. This neutrality has allowed India’s trade with these Gulf Cooperation Council (GCC) countries to increase by 17.8% between January and July 2024 compared to the same period the previous year," said Ajay Srivastava, a former India Trade Services official and founder of economic think tank Global Trade Research Initiative.

“India faces tough times ahead, particularly for industries reliant on high-volume, low-value exports, as rising freight costs are expected to strain trade further. To navigate these turbulent times, India must stay vigilant and adaptable to the fast-changing geopolitical and trade landscape in West Asia," he added.

Experts also said that with Iran escalating its direct offensive against Israel, normalcy will further elude the shipping industry, which was one of the worst impacted sectors due to the unrest in West Asia. Houthi militia attacks in the Red Sea have nearly stopped the usage of the Suez Canal for global shipping, resulting in a surge in freight rates which have now settled in recent weeks. Only a few smaller operators and Chinese flagged ships are using the Suez Canal at present, experts said.

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The Drewry World Container Index, a composite index gauging global freight rates, touched a high of $5937 per 40-feet container in July in light of most west bound shipments from Asia rerouting via the Cape of Good Hope. It has moderated since, as supply chains absorbed the higher shipping times and fuel costs dropped to $3,691 last week, which is still 160% more than the pre-pandemic average of $1,420 in 2019.

The fresh escalations are likely to have a limited impact on freight prices or delays, experts said, as the shipping industry has learnt to work without using the Suez Canal, the global container shipping highway that cuts down the trip between Asia and Europe by several days and a few thousand kilometres.

“Freight rates are largely stable now after as much as five times escalations earlier this year. Now, most of the cost escalations have largely been absorbed with fresh capacity becoming available," said Akshyat Bhatia, vice-president, logistics at Adani Group.

“The bigger concern is the US port strike on the east coast, where 75% of India’s outbound shipments and 50% of US’s imports land. This situation could create a fresh crisis in terms of equipment availability and capacity in weeks to come," he said.

An escalation of fuel prices could result in freight rates surging 5-6% in the short term, according to Raajesh Bhojwani, managing director of RBB Ship Chartering Pte Ltd.

 

Dhirendra Kumar, Priyanka Sharma and Devina Sengupta contributed to this article.