Mumbai: A surge in crude oil prices sent Sensex and Nifty to their steepest drop this year as investors rushed to sell shares today, fearing that rising oil prices will stoke inflation and lead to fiscal slippages in the Indian economy.

The Sensex fell 495.10 points, or 1.26%, to 38,645.18 at the close of trading, while the NSE Nifty index dropped 1.35% to 11,594.45. Crude oil rose to a six-month high after the Trump administration in the US said it won’t renew Iran oil waivers once they expire.

India, the world’s third-largest oil importer, is one of the eight countries that won a six-month waiver to continue importing crude oil from Iran after the US imposed sanctions on the West Asian nation in November.

An increase in oil prices is likely to put pressure on India’s fiscal and current account and comes against the backdrop of the 2019 Lok Sabha elections, where Prime Minister Narendra Modi is seeking a second term.

With US secretary of state Mike Pompeo saying that the Trump administration would no longer grant exemptions, the waiver is set to expire on 2 May. Pompeo said the US, Saudi Arabia and the United Arab Emirates would ensure “appropriate supply" of oil.

In November, the US imposed sanctions on exports of Iranian oil after President Trump unilaterally pulled out of a 2015 nuclear accord between Iran and six world powers. Washington, however, granted waivers to Iran’s eight main buyers—China, India, Japan, South Korea, Taiwan, Turkey, Italy and Greece—that allowed them to continue making limited purchases for six months.

India is a major importer of Iranian oil and imported 23.5 million tonnes in 2018-19 from the country. Of the 220.4 million tonnes of crude imported by India in 2017-18, more than 10% was from Iran.

“From November last year, the Iranian crude oil imports have been subdued," an Indian government official said, requesting anonymity.

India, which imports more than 80% of its oil requirements, will now need to come up with options that offer terms as attractive as those offered by the Persian Gulf nation.

“The ministry of external affairs is in talks with the US State Department. Talks at this level happen on a comprehensive scale across areas of interest between the two countries. We are still hopeful of some concession," the official said.

“Meanwhile, Indian refiners have been de-risking their energy sourcing from varied geographies including Africa, South America and the US."

Crude oil prices have surged over 37% this year. The cost of the Indian basket of crude, which represents the average of Oman, Dubai and Brent crude, was $69.58 a barrel on 17 April, according to the Petroleum Planning and Analysis Cell. The cost of the Indian basket of crude registered an average of $66.74 in March.

The US's move to end the oil waiver comes after the Organization of the Petroleum Exporting Countries (Opec), which accounts for about 40% of global oil production, decided to continue with the supply cuts and the US administration imposed sanctions on Venezuela’s state-owned oil company Petróleos de Venezuela SA.

“The beta rally in the markets was driven by expectations of the US Fed continuing with a dovish stance on the US interest rates benefiting emerging flows and currencies, along with expectations of further rate cuts by RBI and a favourable outcome from the 2019 general elections. Some of the factors (US and India bond yields) have started to reverse in the last few weeks. Key challenges to the beta rally are rising crude price, firm bond yields, earnings and GDP downgrade," said Vinod Karki, vice-president (strategy) at ICICI Securities Ltd.

According to Nomura, India faces two potential supply-side shocks: higher oil prices and the risk of below normal monsoon. However, Nomura believes it is too early to be overly concerned for two key reasons.

“Firstly, the impact of poor monsoon on inflation is not always negative, as weak rural demand may more than offset the lower supply. Secondly, higher oil prices will raise inflation, but its indirect impact will likely be limited as it will crimp consumer demand," it said in a note on 12 April.

The India Meteorological Department (IMD) said monsoon this year is likely to be 96% of the 50-year average, while private forecaster Skymet expects “below normal" monsoon.

The India VIX index, the so-called fear index, gained 6.15% on Monday. The volatility index has an inverse correlation with Sensex. The high number indicates investors don’t expect any major correction over the next month.

Reuters contributed to this story.