Sustaining stability: Fallout of Iran war must be managed sensibly

It remains unclear when the Iran war will end. The biggest reason for this uncertainty is the lack of clarity over the war’s objectives. Iran is raising the cost, not only for the United States (US) and its allies in the region but also for the rest of the world. The effective blockade of the Strait of Hormuz has created a shortage in oil & gas and pushed up prices. After touching nearly $120 per barrel last week, prices of Brent crude oil are hovering around $100. Since India imports over 85 per cent of the crude oil it consumes, and the bulk of the oil comes from West Asia, it is significantly exposed to the crisis. Sustained higher prices, leading to prolonged risk aversion in the global financial system, can also expose other vulnerabilities.

 

Last week, Union Finance Minister Nirmala Sitharaman announced a ₹1 trillion economic stabilisation fund to enable India navigate such global headwinds. Money will come from existing appropriation and additional allocation, though the government is expected to meet the fiscal-deficit target of 4.4 per cent of gross domestic product (GDP) this financial year. Reallocating resources in a crisis is a sensible policy choice. However, a few points are worth making. Despite a sharp increase in crude oil prices, the government could be reluctant to let pump prices adjust, resulting in fiscal pressure. This is because even though prices of petrol and diesel are deregulated, they are not regularly adjusted to reflect market realities. Higher fertiliser subsidies too will lead to additional expenditure. The government may want to support exporters hit by the ongoing war. However, it is not clear how this fund will operate. It is also unclear whether this will be a permanent mechanism, to which money will be allocated every year. If yes, what will happen to the fund in a normal year? Thus, more operational clarity is needed. One of the basic problems in India’s policy management is the lack of policy space to deal with incertitude because it usually runs a high fiscal deficit. Although the government has significantly reduced the fiscal deficit after a sharp increase in the pandemic year, it is still high, particularly when seen in the context of the economy’s financing capacity.

 

Besides the difficulty in fiscal management, the war will also have implications for the external account. The rupee is under pressure. Higher prices of oil & gas will increase the import bill and widen the current-account deficit (CAD). Economists expect the CAD to be about 1.5 per cent of GDP in 2026-27, compared to around 1 per cent in 2025-26. However, a lot will depend on when the war ends and how oil prices move in the coming months. Risk aversion in global financial markets can make the financing of the CAD difficult. India is witnessing capital outflows, which may not reverse in a hurry if the crisis prolongs. Foreign portfolio investors, for instance, have sold India stocks worth over $25 billion since January 2025. There are suggestions to incentivise deposits from non-resident Indians. Although there is pressure on the external front, India has healthy foreign-exchange reserves, which can be used to reduce volatility in the foreign-exchange market to an extent. However, those should not be used to defend the currency. In the given circumstances, the rupee is expected to depreciate and it should be allowed to do so in an orderly way.