Rising geopolitical tensions stemming from the conflict between the United States and Iran pose significant challenges for the global economy, with particular implications for major oil importers like India. Sameer Karyatt, Managing Director and Head of Trading at DBS Bank India, recently outlined how a prolonged conflict could reshape India’s macro-outlook, affecting inflation, interest rates, and foreign investment.
Economic Fallout for India
Karyatt warns that if the US-Iran conflict persists for an extended period, India could face several adverse economic consequences. The country's current account deficit (CAD) might widen significantly, potentially reaching 2–2.5% of GDP. Simultaneously, the fiscal deficit could deteriorate by 0.5–0.7% of GDP, placing additional strain on government finances.
Inflation is also projected to see a substantial increase, with an estimated rise of 100–150 basis points. Beyond macroeconomic indicators, specific sectors are expected to bear the brunt of supply-side disruptions, particularly manufacturing and hospitality.
Global Inflation and Stagflation Risks
Globally, inflation remains a persistent concern, largely driven by commodity prices that are anticipated to stay above pre-war levels. This environment creates a risk of stagflation, characterized by slower economic growth coupled with elevated inflation. Karyatt emphasizes that ongoing geopolitical conflicts are likely to sustain pressure on energy prices, potentially prolonging this period of high inflation worldwide.
Rupee Depreciation and Interest Rates
Amid rising oil prices and global uncertainty, the Indian rupee has experienced record lows. While the Reserve Bank of India Governor has indicated that a 3% depreciation of the Indian rupee is embedded in the country’s economic fundamentals, Karyatt suggests a structural weakness for the INR over the medium term, given current global macroeconomic conditions impacting India’s current and capital accounts.
The trajectory of interest rates in India is also closely tied to the duration of the conflict. A prolonged war would substantially increase the likelihood of higher interest rates, directly translating to a rise in Equated Monthly Installments (EMIs) for borrowers.
Foreign Investor Concerns
Foreign Portfolio Investor (FPI) flows into Indian markets have shown a sharp outflow, driven by challenges to their primary objectives: capital gains and net interest income. Elevated crude oil prices and inflationary pressures have led to rising yields, diminishing the potential for capital gains. Concurrently, high hedging costs are eroding net interest income, reducing overall returns for FPIs. If these elevated hedging costs persist, maintaining investments in India will become considerably more expensive for foreign investors.