The war in West Asia has exposed India to risks not seen in over a decade. The pressure on the current account deficit (CAD) is mounting, the rupee is depreciating, and demand needs to be curbed to adjust to supply chain disruptions.
Against this backdrop, Prime Minister Narendra Modi, late on Sunday, urged citizens to adopt austerity measures to help navigate pressures.
Yet, India is still in a better position than the ‘fragile five’ era of 2013. The current scenario, however, requires policy measures, such as a hike in fuel prices and higher gold duties, to keep the macro situation in check.
Fragile five refers to a group of emerging economies identified during the 2013 taper tantrum as highly vulnerable to external shocks due to large CAD, high inflation, and dependence on foreign capital flows. India gradually moved out of the category post 2014.
India’s current account deficit is expected to rise to 2.2% of GDP in FY27, deteriorating sharply from 1.0% of GDP in April-December. This will push the figure to the highest in 14 years. Yet, this will only be halfway to the 4.8% of GDP figure seen in FY13, a situation that prompted Morgan Stanley to club India among the fragile five economies in 2013.
Other macro numbers are showing signs of deterioration: GDP growth is expected to slow down to 6.6% in FY27 from 7.6% in FY26, inflation is seen rising to 5.1% from the pre-war average of 1.9%, and fiscal deficit could reach 4.5% compared to the budgeted 4.3% for FY27. The rupee's rapid depreciation has been a major cause of concern. While none of these is close to the fragility seen in FY13, the rapid deterioration of macros from the pre-war period calls for action.
India has so far refrained from announcing measures to curb demand, unlike several other countries vulnerable to the West Asia war.
“I don’t think it (PM Modi’s call) really translates to things on the ground without regulatory changes or without curbs from a rules-based policy making that we can expect to happen in the coming weeks,” said Dhiraj Nim, an economist and FX strategist at ANZ. Strict measures on gold imports alone could ease pressure by 10-15 basis points, but more regulations will still be needed to address the situation, he added.
Forex strain
India is heavily dependent on crude oil and vegetable oil imports to meet its domestic needs. It also sees heavy gold imports, often leading to a high trade deficit. Travel has become the latest addition that is exerting pressure on India’s current account deficit.
By and large, India has been funding its current account deficit through a mix of foreign direct investment, foreign portfolio investments, and remittances, among others. Currently, India is facing an unprecedented FPI outflow.
Remittances, about 40% of which come from West Asia, are also under strain. These have put immense pressure on India’s forex reserves in managing the rupee. Since the beginning of the war, the Reserve Bank of India (RBI) has burnt nearly $38 billion in forex reserves, leading to a decline in import cover to 10.7 months currently, as opposed to 11.3 months before the beginning of the war.
Moreover, over the past year, the RBI built up gold reserves, accounting for about 16% of total reserves. Excluding these, the import cover comes down by roughly two months.
Despite forex interventions and strict measures like curbing speculation in the forex market, the rupee has continued to decline, hitting a new record low of 95.63 against the dollar early on Tuesday.
“The primary reason why they are doing verbal intervention (austerity calls) is because of the impact of higher oil and gold imports on the current account deficit, at a time when capital inflows are also limited,” said Radhika Piplani, chief economist at Motilal Oswal Financial Services. “In my view, there might be a retail pump price hike in the offing or some measure to curb gold imports, if global tensions do not ease,” she added.
Burden sharing
The prolonged closure of the Strait of Hormuz has exacerbated oil and gas supply. Currently, oil and derivatives markets continue to suffer supply losses of at least 10% of global supply. Even if transit through Hormuz improves, damage to oil and gas infrastructure in West Asia could weigh on supplies.
The economic repercussions of the West Asia conflict are expected to be protracted. According to a report by PL Capital, there is an imbalance of roughly 4.8 million barrels per day in global oil supply, which is expected to be absorbed via demand destruction across the globe.
India, the third-largest consumer of crude oil, will have to take measures in the same direction. “Since the Middle East conflict started, fiscal policy has been India’s first line of defence, which has minimized the growth/inflation trade-off but worsened the twin fiscal and current account deficits,” said Nomura in a report.
“PM Modi’s comments signal that the pressure on the government fiscal finances is reaching a tipping point, that there is less appetite for further rupee depreciation, and that the burden of adjustment may be incrementally shared with consumers,” it added.