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Business News/ Economy / Explained | Upside risk on inflation to export woes—here's how the Red Sea crisis will impact Indian economy in FY25
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Explained | Upside risk on inflation to export woes—here's how the Red Sea crisis will impact Indian economy in FY25

The finance ministry said that high crude oil prices as a result of the Red Sea crisis may pose upside risks on India's inflation, economic growth and the value of merchandise exports.

This aerial photograph shows a view of the city of Yanbu at the Red Sea, at the end of the stage 11 between Al-Ula and Yanbu, Saudi Arabia, of the Dakar rally 2024. (AFP)Premium
This aerial photograph shows a view of the city of Yanbu at the Red Sea, at the end of the stage 11 between Al-Ula and Yanbu, Saudi Arabia, of the Dakar rally 2024. (AFP)

The ongoing crisis in the Red Sea shipping route is putting an upside pressure on global food prices, with longer cargo travel distances and higher freight rates potentially leading to an increase in cost. The finance ministry said in its monthly economic review for February 2024 that high crude oil prices as a result of the Red Sea crisis may pose upside risks on India's inflation, economic growth and the value of merchandise exports.

The attacks on shipping in the Red Sea have resulted in trade flows being re-routed so that the shipping costs have risen sharply, and delivery times have lengthened, especially for trade from Asia to Europe. The economic review said quoting a United Nations Conference on Trade and Development (UNCTAD) report that the Suez canal experienced a drop in transits by 42 per cent and 49 per cent, respectively in January 2024 compared to their peak levels.

Also Read: India's FY25 growth outlook looks bright, core inflation on downtrend, says FinMin: 5 key highlights

Impact of Red Sea Crisis on the global economy:

Change in trade route: Container ships routing through the Suez Canal are shunning and rerouting around the Cape of Good Hope. By the first half of February 2024, container tonnage crossing the Canal fell by 82 per cent, and vessel tonnage passing through the Cape of Good Hope increased by 60 per cent.

Increase in the distance and operational shift due to rerouting of ships: The extra miles travelled and days lost due to trade diversion has translated into additional costs such as fuel costs and lost value of time-sensitive cargo. The other additional costs are arising from the security considerations, including the risk of piracy, which generates a surge in insurance and legal claims.

• Signs of rising inflationary pressures: The current container freight rates are approximately half the peaks recorded during COVID-19. Sustained increases in shipping costs due to disruption can drive up inflation. The crisis is also reverberating in global food prices. Disruptions in grain shipments from the Russian Federation, Ukraine, and Europe pose risks to global food security.

“Heightening tensions in the Middle East, especially on the critical Red Sea global shipping route, could potentially trigger a second wave of inflation in 2024. Disruptions to the supply chain typically lead to increased costs for transportation, production, and distribution, which may ultimately be passed on to consumers,'' said Nigel Green, deVere Group’s chief executive officer.

“As demand outpaces supply, prices may rise, contributing to inflation. Industries heavily reliant on just-in-time inventory systems may be particularly vulnerable to such disruptions," notes Nigel Green.

Also Read: Mint Primer | India and the Red Sea sharks: crisis without an end?

Impact of Red Sea crisis on the Indian economy:

• 80 per cent of India’s merchandise trade with Europe passes through the Red Sea, with key products such as crude oil, auto & auto ancillaries, chemicals, textiles, and iron and steel being affected. The combined impact of higher freight costs, insurance premiums, and longer transit times could make imported goods significantly more expensive.

• A sustained disruption in trade routes holds the potential to impact the capital goods sector, with the ripple effects potentially leading to an undesirable inventory build-up, the economic review said quoting a CRISIL report.

• The conflict has impacted the Middle East’s fertiliser exports to India as import of the Muriate of Potash from Jordan and Israel has been affected. The crisis will impact economic growth and inflation across Asia, according to BMI -a Fitch Solutions company.

• Asian economies such as China, Japan, India, and South Korea are among the largest net oil importers globally. Hence, continued shipping disruptions could hit Asia. A rise in crude oil prices may pose upside risks to inflation and, consequently, to the gross domestic product (GDP) growth.

Also Read: Red sea trade disruptions to affect the fertiliser, capital goods sectors the most: Crisil report

The finance ministry added in the report that rejuvenating demand scenarios in the advanced economies are expected to have a positive impact on India. However, India may face a sectoral impact on agricultural commodities, marine products, textiles and chemicals, capital goods, and petroleum products. 

In order to effectively address these challenges, there may be a need to diversify trade routes and transportation options. ‘’That would increase transit costs and affect the price competitiveness of Indian merchandise exports. We have to see if it impacts the value of merchandise exports in FY25,'' said the finance ministry in the economic review.

Analysts highlight impact on Indian economy:

The Red Sea crisis has prompted Asian refiners to reassess their oil policies and develop alternative plans to secure steady feedstock flows, according S&P Global Commodity Insights. According to Zhuwei Wang, Asian oil analytics manager at the firm, the Red Sea crisis affects Asian oil flows in three ways.

Potential hurdles for Russian crude flowing to Asia, cautiousness among exporters of products moving north-bound from Asia to Europe, and longer routes leading to incremental bunker demand in Asia. "First, any escalation will create hurdles for Russian crude flowing to Asia, forcing buyers to look for substitutes from other origins," said Wang.

"Secondly, for products moving northbound from Asia to Europe, exporters are cautiously watching developments before taking the plunge. Additionally, longer routes have the potential to create incremental bunker demand in Asia," he added.

While immediate impacts on near-term oil supplies appear limited, the situation has refiners contemplating alternative routes to ensure uninterrupted feedstock supply, potentially leading to increased insurance costs and squeezed refining margins.

Also Read: An attack on a cargo ship in the Red Sea has caused a miles-long oil slick. Things could get worse

Coming to the domestic economy, the capital goods sector has been dealing with major changes since the onset of the Red Sea crisis. On the forefront, rise in costs and timeline of deliveries are among the key problems.

"The impact of the ongoing crisis around the Red Sea on the capital goods is causing delays in the timely delivery of goods leading to slowdown in the crucial process of order conversions along with an increase in logistics costs. The effect of disruptions extends to various facets of the industry leading to an undesirable inventory buildup,'' said Avinash Pathak, Research Analyst at LKP Securities

‘’Consequently, the sector could grapple with the dual challenges of managing excess inventory and a deceleration in the conversion of prospective orders, impacting the overall business dynamics and performance of these enterprises. However, the impacted companies are making provisions for the same while the long terms prospects remain positive in the sector,'' added Pathak.

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ABOUT THE AUTHOR
Nikita Prasad
Nikita covers business news and has been producing news on digital platforms since 2018. She writes on economy, policy, markets, commodities, industry. Her core areas of interests include infrastructure, energy, oil and gas, railways, and transport/mobility. She has worked for business news channels like Moneycontrol, NDTV Profit, and Financial Express in the past. If you have story ideas/pitches/reports or quotes/views to share, reach her at nikita.prasad@htdigital.in.
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Published: 22 Mar 2024, 07:36 PM IST
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