Iran conflict threatens sweet-spot economy

Just when things seemed to be finally going right for the $3.8 trillion Indian economy, war has broken out between Iran and U.S.-Israel and engulfed other parts of the Middle East, bringing to the fore risks to the South Asian nation's external sector that have not been fully priced in.  

Can a protracted conflict prematurely end the economy's Goldilocks phase? That's our focus this week. Write to me with your views at ira.dugal@thomsonreuters.com.

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And, technical incidents at Air India have risen. Scroll down for more on that Reuters exclusive.

The Indian economy has been chugging along at a strong pace of growth with low inflation, and the overhang of high U.S. tariffs has been lifted recently. But the Iran versus U.S.-Israel military conflict threatens to upend it.

The risks of an extended conflict in the Middle East, analysts say, could range from higher commodity prices to lower worker remittances and disruptions to businesses that have diversified to the flourishing economies in the region.

"A prolonged conflict, alongside a large jump in energy prices, would be a major macro negative (for India)," brokerage Jefferies said in a note on Monday.

The region accounts for 17% of India's exports, provides 55% of crude oil and 38% of worker remittances, it said.

Oil prices surged 8% on Monday following the military strikes over the weekend, with Brent crude for a while trading above $82 a barrel.

Prices could spike to $100 per barrel, Barclays said.

Global energy markets could face one of their gravest crises in decades with the scale of disruption likely to be determined by the duration of the conflict, Reuters Open Interest columnist Ron Bousso wrote. Read that piece here.

India could be among the most vulnerable if higher oil prices are sustained, analysts said. Read here to understand why. Government officials said on Monday steps will be taken to ensure local fuel supplies.

Every $10 per barrel increase in oil prices widens India's current account deficit to GDP ratio by 0.5%, Mumbai-based brokerage Emkay Global Financial Services said. It can add up to 35 basis points to retail inflation and hit GDP growth by 15-20 basis points, the brokerage added.

Nomura economists said that an extended increase in fuel costs could prompt governments in the region to use higher subsidies and lower taxes to protect consumers from the impact. "Higher oil prices solidify the case for central banks to stay on hold," they said.

Disruption of crucial sea routes could also hurt. Roughly a third of global seaborne crude oil exports pass through the Strait of Hormuz, with most volumes destined for economies such as China, India, Japan and South Korea, Moody's Analytics said.

An added risk for India is another spurt in already-high gold prices. Together oil and gold accounted for nearly a third of India's import bill in value terms in the current financial year till January.

Indian asset markets reflected these risks in Monday's trading, with equities and the rupee sliding and bond yields rising.

India is walking a tightrope in the conflict, boasting historical cultural ties with Iran and strong strategic relations with Israel. Prime Minister Narendra Modi held talks with Israeli Prime Minister Benjamin Netanyahu in Jerusalem just last week.

Weakness in the economies of Middle East nations could also hit large remittances that India gets from workers in the region, while putting businesses at risk.

Larsen and Toubro, India's largest engineering and construction company, has nearly 40% of its engineering, procurement and construction order book coming from the region, Jefferies said. A few consumer goods companies such as Dabur and Titan, along with pharma firms, also have material revenues linked to the Middle East, it said.

Additionally, airlines and tourism companies could be at risk of hits to profits if oil prices remain high and travel remains disrupted.

Extended uncertainty could also weigh on the near 10 million Indian workers in the Middle East, according to government data, many of whom send earnings home, boosting household finances and acting as a major source of foreign currency inflows into India.

The widening of the conflict across the region could slow down remittances, said Emkay Global, adding, though, that this was not their base case.

India's economy grew at 7.8% in the October-December period and is seen expanding at 7.6% in the current financial year, according to data released by the government under a revamped GDP series.

Read here for the key takeaways and catch up on views from economists here.

The new series is expected to provide a clearer read on the economy as it widens the sources of information, shifts to a more technically sound way of computing real GDP growth and updates the base year.

Technical incidents such as engine oil and fuel leaks affecting Air India flights reached their highest rate in at least 14 months in January, Reuters'  Abhijith Ganapavaram and Aditya Kalra reported.

The airline in December said there was a "need for urgent improvements in process discipline, communication, and compliance culture".

In January, Air India recorded 1.09 technical incidents per 1,000 flights, quadrupling from levels of just 0.26 in December 2024.

Read that exclusive report here.    

Protests were seen across many parts of the world, including in India, after the U.S. and Israel launched air strikes against Iran, killing Iran's Supreme Leader Ayatollah Ali Khamenei.

Click here for a graphical representation mapping the crisis in Iran.

This newsletter was edited by Muralikumar Anantharaman, Editor, Global News Desk, in Singapore.