West Asia conflict may lead to demand shock: RBI Governor Sanjay Malhotra

Elevated crude oil prices could raise imported inflation and widen the current account deficit, he says

The West Asia conflict could trigger a “demand shock” if disrupted supply chains are not restored soon, said Reserve Bank of India (RBI) Governor Sanjay Malhotra on Wednesday.

 

He made the statement hours after US President Donald Trump agreed to a two-week ceasefire with Iran, signalling a temporary de-escalation in tensions. The ceasefire depends on Iran reopening the Strait of Hormuz, with Trump saying that he has received a 10-point proposal from Tehran for further engagement.

 

Iran said it will allow safe passage for ships in the Strait during the ceasefire, while discussing the possibility of levying fees in coordination with Oman for reconstruction efforts.

 

 

High crude prices could increase India’s inflation and widen the current account deficit, Malhotra said, explaining the likely impact of USA and Israel’s war against Iran. Disruptions in energy markets, fertilisers and other commodities may hurt industry, agriculture and services, reducing domestic output.

 

Heightened uncertainty, increased risk aversion and safe-haven demand could pressure domestic liquidity conditions, economic activity, consumption and investment, he said, adding that weaker global growth prospects may dampen external demand and reduce remittance flows.

 

“Finally, adverse spillovers from global financial markets could tighten domestic financial conditions and raise the cost of borrowing. Overall, the initial supply shock can potentially transform into a demand shock over the medium term if the restoration of supply chains is delayed,” Malhotra said.

 

Despite the risks, Malhotra said India’s macroeconomic fundamentals are stronger than in previous crises and compared to many other economies.

 

The RBI’s six-member monetary policy committee (MPC) on Wednesday voted unanimously to keep the benchmark policy rate unchanged at 5.25 – the second consecutive pause by the panel.

 

“The MPC opined that the intensity and the duration of the conflict and the resultant damage to the energy and other infrastructure add risk to the inflation and growth outlooks. However, the fundamentals of the Indian economy are on a stronger footing, providing it with greater resilience to withstand shocks now than in the past. The economy is confronted with a supply shock. It is prudent to wait and watch the changing circumstances and the evolving growth-inflation outlook,” Malhotra said in his policy statement.

 

“Accordingly, the MPC voted to keep the policy rate unchanged even as it remains vigilant, closely monitoring incoming information and assessing the balance of risks. The MPC also decided to continue with the neutral stance, retaining the flexibility to respond judiciously to incoming information.”