- The Iran conflict has kept Brent crude prices about 30% above pre-war levels
- India imports 85% of its energy, facing inflation-growth trade-offs amid oil price hikes
- Former RBI Governor Subbarao advises allowing rupee to fluctuate with fundamentals
The war in Iran has tipped the global economy into fresh turmoil. With the Strait of Hormuz, a vital conduit for more than 20 per cent of global oil flows, repeatedly disrupted, crude has remained sharply elevated-Brent remains roughly 30 per cent higher than before the conflict began in late February, after spiking to well above $110 per barrel at its peak.
The shock has rattled energy markets worldwide, including India, which imports 85 per cent of its energy needs. The energy crisis worldwide has forced central banks everywhere into an uncomfortable trade-off between defending growth and containing imported inflation because of the Middle East conflict. With elevated crude prices forcing the government to increase prices of both petrol and diesel, the Reserve Bank of India is no exception to this policy conundrum. The hikes, though, have been lower than in other nations, and India seems to be relatively less affected.
In fact, former Reserve Bank of India Governor D Subbarao has said India is in a far stronger position to absorb the blow than it was during the 2013 currency crisis, and that the central bank should allow the rupee to fluctuate in line with economic fundamentals rather than spend heavily to prop it up.
Speaking to NDTV's Gaurie Dwivedi as the rupee continues to swing sharply, down nearly 7 per cent this year and having briefly touched 97 to the dollar, Subbarao, who led the RBI from 2008 to 2013, said the currency had been under pressure even before the conflict, largely on account of capital outflows that had made it one of the weakest-performing Asian currencies.
The Iran crisis and the resulting spike in oil prices, he said, have added fresh strain on the current account, which is expected to widen from 1 per cent of GDP last year to around 2.5 per cent. His central prescription was that the RBI should not fight the market. "It is best to let the rupee move consistent with economic fundamentals," he said, arguing that a widening current account is itself a signal that the currency must depreciate to correct the deficit. The central bank, in his view, should intervene only to smooth out volatility and otherwise be "minimalist"-warning that heavy intervention to defend the rupee against fundamentals is costly and can ultimately fuel inflation.
Drawing a sharp contrast with the 2013 episode, when India was branded one of the "fragile five" emerging-market economies, Subbarao said the country is no longer in that company. Back then, he recalled, India faced the spectre of stagflation-high inflation alongside low growth-compounded by talk of policy paralysis. This time, he said, India has entered the crisis with relatively strong fundamentals, robust growth, and benign inflation. The fiscal deficit, while still high, rests on a more credible adjustment path; the current account, even at 2 to 2.5 per cent, remains manageable; and foreign exchange reserves, which were limited in 2013, now stand close to $700 billion, high by any conventional measure.
Unlike 2013, when India stood out as a vulnerable outlier, this is a synchronised global shock in which almost every economy is grappling with the same turmoil.
Even so, Subbarao was candid about the difficult road ahead. He pointed to the RBI's own estimate that every $10 rise in oil prices shaves 20 to 30 basis points off growth while adding 30 to 40 basis points to inflation.
With crude still elevated, the central bank now faces a "formidable" and near-impossible task of simultaneously checking inflation, supporting growth and stabilising the rupee-an "impossible trinity" made harder by the exchange rate being a third variable alongside growth and inflation. While there is no real conflict between growth and inflation over the long or medium term, low, steady inflation being a precondition for growth, he acknowledged that short-term tensions are real, since raising rates to fight inflation or defend the currency inevitably weighs on growth.
Subbarao credited the government with taking steps within its control, including raising customs duty on gold to curb import demand and partially passing on higher fuel prices while absorbing some of the burden through excise duty cuts. Pushing up fuel prices is politically difficult, he said, "but in a situation like this, we elect leaders to take politically difficult decisions."
Looking beyond the immediate crisis, Subbarao said the average oil price for the year could stay as high as $90 a barrel or more, having climbed from about $75 before the war to around $120 at its peak, and that even a conservative $90 average would inflict considerable pain on growth, inflation, and the external sector. The bigger lesson, he argued, lies in the medium term: in an increasingly uncertain geopolitical environment, India must prioritise not just growth but resilience, including building up strategic energy reserves, to withstand shocks of this kind.
