Gulf war imperils growth and inflation, dims rate cut hopes
The US-Israel-Iran war and the consequent tension across West Asia wiped out an estimated ₹19 lakh crore in market capitalisation from Indian bourses this week. Both benchmark indices continued their declines, with the Sensex crashing by more than 1,000 points on Friday to close the week at 78,918, while the Nifty stayed below the crucial 25,000 support level. What is more worrisome than the market mayhem is that rising oil prices and disrupted gas flows have not only triggered widespread sell-offs across equity, debt and currency markets, but also reignited fears of rising inflation and slowing growth—a phase India painstakingly managed to overcome this fiscal. Above all, rising oil prices have pushed the rupee to a record low of 92.10 against the US dollar this week, besides raising concerns about a higher current account deficit.
An extended conflict in West Asia—which accounts for 17 percent of India’s exports, 55 percent of its crude oil imports and 38 percent of remittances—will adversely affect the Indian economy, which is in a sweet spot thanks to sustained growth, low inflation, softening interest rates, a low current account deficit and a restrained fiscal deficit. While India’s growth prospects remain strong, the oil price shock comes at a crucial juncture. As it is, the revised GDP series recently reduced the economy’s size by about ₹12 lakh crore, and a fuel shortage would significantly impact both industry and households. If supply stays disrupted for even one month, its impact can stretch to at least two quarters. On its part, the government said it has enough stocks and will ensure timely supplies, but the situation needs close monitoring.
The RBI sold as much as $12 billion this week to defend the rupee and may continue its support given India’s robust foreign exchange war chest, with reserves at over $723 billion. The biggest worry, though, is the growth-inflation trade-off. Every $10 increase in per-barrel oil prices widens the current account deficit by 0.5 percent of GDP, adds 20-35 basis points to headline inflation, and reduces growth by at least 15-20 bps. Until last week, expectations of an interest rate cut in April were high; but the Gulf war has reduced those chances. Despite looming fears of high inflation, the RBI may remain hawkish to support growth above everything else.