Preparing the response

Three axes along which India must respond to West Asian crisis

The killing of top Iranian general Qassem Soleimani by the US during his visit to Iraq has shaken up the situation in West Asia, moved the region closer to an armed confrontation, and caused oil prices to react sharply. Soleimani, as leader of the Quds Force — which is the division that carries out the extra-territorial influence and insurgency operations of the Islamic Republic of Iran — was a major player in the politics of the region and had become enormously powerful and popular in Iran itself. A cycle of response and escalation might result. If so, it is not easy to predict the path of oil prices in the short- to medium-term.  US shale oil output has been robust but demand in the global economy has been weak. The market was on its way to oversupply anyway. But any low-level conflict might target oil infrastructure. Depending on what is taken out of the supply chain and for how long, this may create a scarcity that forces prices upwards in the short- or medium-term. 

There are, thus, three axes along which the Indian government will need to prepare. These axes have been the same for some decades — and are the cause of India’s dependence upon stability in the West Asian region. First, of course, is the supply of oil. India imports 84 per cent of the oil it needs. Thus, a spike in the price of oil makes a big difference not just to domestic cost conditions but also to the balance of payments. An increase in oil prices will naturally cause inflationary pressures throughout the economy; the Reserve Bank of India will, therefore, be forced to exercise greater caution than it would have otherwise when it comes to setting interest rates. In the past, high oil prices have severely weakened the external account; a previous crisis in West Asia was, in fact, part of the reason for the balance of payments crisis that precipitated the 1991 liberalisation. Today, India’s foreign exchange reserves are relatively comfortable, at over $450 billion, and can easily cover 9-10 months’ imports at current prices. An increase in the price of oil would have to be both sharp and sustained in order to erode this buffer. 

However, there are two other axes of concern for the government, and both are related to the large Indian diaspora in West Asia, and particularly the Persian Gulf. Their safety will have to be a priority. India has in the past organised big evacuations — famously from Kuwait at the time of the first Gulf War, and more recently from Libya. The scale of any evacuation from the Gulf would on this occasion be even larger even if it remains relatively unlikely. A downturn caused by tensions, however, might cause a large number of guest workers to return to India — and to stop remitting money. In 2016-17, for instance, 27 per cent of remittances into India came from the United Arab Emirates, and 27 per cent from other Gulf states. This inward flow is concentrated geographically as well, with more than half flowing to Kerala, Maharashtra, Tamil Nadu, and Karnataka. A sharp decrease in remittance income would further stress the external account and the economies of these states. The Indian government should thus keep a wary eye on developments in the Gulf and make its own preparations.