India’s Inflation And Fiscal Deficit Situation Could Be Severely Impacted By Isreal-Iran Conflict; FPIs Offload ₹20,000 Crores In Indian Equities In 4 Sessions; Should We Brace For Inflation And Soaring Oil Prices?

Inflation, Oil Prices, FPIs Sell Out And More, Israel-Iran Conflict

Economic experts have sounded the alarm about the deepening implications of the escalating tensions in the Middle East for India, mainly if there is a sustained surge in oil prices. 

The ongoing conflict between Israel and Iran, coupled with broader geopolitical instability, have all cast a shadow over India’s economy, with crude oil prices emerging as a focal point of concern. 

Hence, these factors have sparked nervousness regarding potential repercussions on various economic fronts, such as inflation, fiscal deficit, and the current account deficit.

What Has Happened So Far

The recent exchange between Israel and Iran states the volatility in the region, with Iran’s retaliatory action following an alleged Israeli airstrike on its consulate in Damascus, which heightened tensions. 

As Iran launched many drones and missiles against Israel in response, India finds itself in a damning position, vulnerable to the ripple effects of this geopolitical turmoil. 

Despite United States calls for restraint and other allies of Israel, the situation remains fluid, with the possibility of further escalation looming large.

The Surge In Oil Prices

Of particular concern is the risk of a surge in oil prices, which poses a direct threat to India’s economic stability. 

While India has taken steps to diversify its sources of oil imports, such as Russia, it still remains heavily reliant on Gulf countries for a significant portion of its crude oil needs. 

Hanna Luchnikava-schorsch, Principal Economist at S&P Global Market Intelligence, emphasises the potential ramifications of sustained oil price increases on the Indian economy. 

She emphasizes that such a scenario could lead to higher inflation, widening trade and current account deficits, weakening the rupee, and straining public finances.

India’s vulnerability to global oil price fluctuations is accentuated by its reliance on imported crude oil, which accounts for over 80 percent of its requirements. 

Hence, the looming threat of disruptions to oil supplies from the Middle East, compounded by the strategic significance of the Hormuz Strait, through which a substantial portion of global oil transit, further aggravates concerns. 

In the event of prolonged conflict and subsequent disruptions to oil flows, India would likely face the dual challenge of soaring crude oil prices and potential supply constraints, which would have critical implications for its economic stability and growth trajectory.

The Ministry of Finance announced yesterday that it is closely monitoring the Israel-Iran tensions to gauge their potential impact on the Indian economy. An official from the ministry expressed concerns regarding a possible rise in global oil prices.

Meanwhile, Shreya Sodhani, Regional Economist at Barclays, suggested that despite any escalation in the Middle East, India may not feel immediate effects due to its access to Russian oil. 

She pointed out that while a $10 increase in crude oil prices typically leads to a 0.3 percentage point rise in India’s inflation and current account deficit, recent government fiscal measures have kept retail fuel prices stable for two years, allowing oil-marketing companies to reap significant profits. 

Sodhani doubted the government’s willingness to burden consumers with higher energy costs, especially with elections looming.

Economists anticipate that although the conflict could drive crude oil prices above $100 per barrel, managing within this price range is feasible. 

Suman Chowdhury, Chief Economist at Acuité Ratings & Research, highlighted the possibility of crude oil breaching the $100 mark if tensions in West Asia escalate further.

Sectors That May Be Affected

Infomerics Ratings identified oil-dependent industries such as automobiles, transportation, aviation, paints, tyres, cement, and chemicals as the most vulnerable. 

Additionally, Indian stocks with ties to Israel, including Adani Ports, Sun Pharmaceutical, Dr. Reddy’s, Lupin, NMDC, Kalyan Jewellers, and Titan, could be affected. 

Similarly, oil marketing companies may also face adverse consequences. 

Dr. Manoranjan Sharma, Chief Economist at Infomerics Ratings, suggested that the conflict might hinder India’s plans for an India-Middle East-Europe Economic Corridor, as reflected in the performance of railway stocks like IRCON, Jupiter Wagons, and RVNL.

Suman Chowdhury from Acuité Ratings & Research noted potential areas of impact, emphasising that oil PSUs may face higher under-recoveries until the increases in crude prices are reflected in petrol, diesel, and LPG prices. 

He further pointed out that prices for oil derivatives are expected to climb, affecting operating margins in sectors such as petrochemicals, speciality chemicals, and paints.

Contributing To Inflation

Israel-Iran escalation could lead to higher inflation and current account deficits for India, alongside fiscal deficits and reduced profitability due to diminished pricing power resulting from lower demand. 

Hanna Luchnikava-schorsch from S&P Global noted that while India has seen a decline in consumer price inflation, a rise in oil imports and fuel subsidies could exert upward pressure on deficits and the rupee exchange rate, potentially triggering inflation and hindering economic recovery.

Likewise, Dr. Manoranjan Sharma, Chief Economist at Infomerics Ratings, emphasized the negative impact of surging oil prices on India’s trade deficit, current account, and fiscal deficit. 

He acknowledged that while market sentiment could suffer, it’s crucial to recognize the resilience of the Indian economy for a comprehensive perspective.

Acuité Ratings & Research forecasts GDP growth and retail inflation at 6.7 percent and 5.0 percent, respectively, for FY25, but acknowledges the vulnerability of these projections to revisions if the Iran-Israel conflict escalates further. 

Meanwhile, S&P Global Market Intelligence’s baseline forecast anticipates a moderation in India’s consumer price inflation, but warns that a significant rise in global oil prices could reverse this trajectory, potentially prompting the RBI to raise interest rates and tighten financial conditions, with adverse effects on growth. 

Hanna Luchnikava-schorsch stressed the importance of monitoring oil price fluctuations for their impact on India’s economic trajectory.

Playing The Difficult Diplomatic Game

As Dr. Manoranjan Sharma summarized, expressing concerns about India’s complex relationships with both Iran and Israel, stressing the challenges they pose on policy and operational fronts. 

While Israel remains a trusted defense and security ally, Iran’s significance lies in its role as a major crude oil supplier and shared concerns about terrorism, Afghanistan, and the strategically important Chabahar port. 

Sharma emphasized the turbulent times ahead, acknowledging the gathering storms and uncertain days.

The FPI’s Massive Sell Out

Further, against the backdrop of escalating tensions between Iran and Israel and a notable increase in U.S. bond yields, foreign portfolio investors (FPIs) have divested over ₹20,000 crore from Indian equities in just four trading sessions. 

FPIs sold ₹4,260 crore on Thursday, followed by ₹4,468 crore on Tuesday, ₹3,268 crore on Monday, and ₹8,027 crore on the preceding Friday, as reported by the National Stock Exchange (NSE).

As a result, Indian benchmark indices have witnessed significant declines in recent sessions, with both the Nifty 50 and Sensex experiencing losses of 2.85% and 2.9%, respectively, over the past five trading days.

The trend of FPI selling extends beyond India, with foreign investors divesting from stocks in other emerging markets, seeking safer opportunities in assets like government-backed bonds and gold. 

This shift in investment sentiment comes amidst a consistent uptrend in US bond yields since March, driven by stronger-than-expected inflation data and robust retail sales indicating resilient consumer spending despite record-high interest rates.

US Federal Reserve Chair Jerome Powell’s remarks on the lack of progress towards achieving the inflation goal suggest a continued tight policy stance until inflation trends consistently approach the 2% target. 

Consequently, expectations for the timing of the first rate cut have been pushed back from the previously anticipated June date.

Meanwhile, reports indicate that manufacturing activity in the US Mid-Atlantic region expanded significantly in April, reflecting strength in new orders and shipments of finished goods, despite a decline in factory employment.

Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, noted that the sharp increase in US bond yields triggered significant FII selling, reaching ₹4,260 crore on the previous day, with expectations of further selling in the near term. 

This uncertainty has led investors to await clarity on the geopolitical front, as uncertainty remains high.

The impact of FPI selling was also felt on the Indian rupee, which depreciated to another historic low of 83.83 against the US dollar in today’s trading session.

The Last Bit, Should India brace for inflation and soaring oil prices amid escalating tensions between Iran and Israel? 

The answer is most likely yes.

Economists warn that a sustained increase in international oil prices could lead to higher inflation, wider trade and current account deficits, and a weaker rupee, contributing to existing economic vulnerabilities. 

India is heavily reliant on imported crude oil, accounting for over 80% of its needs. As such, the country is particularly vulnerable to fluctuations in global oil markets and may need to prepare for potential disruptions to oil supplies and the consequent impact on inflation and economic stability. 

Likewise, the recent surge in U.S. bond yields and subsequent divestment of over ₹20,000 crores in Indian equities by FPIs amidst rising geopolitical risks suggest a need for vigilance and signalling turbulent times ahead. 

With FPIs offloading Indian equities and the Indian rupee plummeting to historic lows, the economic repercussions are likely. 

Moreover, uncertainties surrounding the U.S. Federal Reserve’s policy stance and geopolitical tensions necessitate a cautious approach.