Tuesday's Talking Points
Escalating conflict: Implications for India’s Trade and oil supply
What’s the Point?
Oil markets and global supply chains have been under pressure as the geo-political situation in the Middle East has deteriorated. One year since the October 7 attack in Israel, the situation seems far from resolution, with forces like the Houthi rebels continuing to disrupt shipping movement in the Red Sea and the Suez Canal route, forcing ships to take the Cape of Good Hope route. For India, 35% of overall trade is with countries in Europe, North and South America, and parts of Africa for which the Suez Canal is used. Involvement of Crude Oil producers such as Iran, have led to an increase in oil prices. 21% of global oil trade passes via the Strait of Hormuz, which is at risk in the ongoing conflict. India’s heightened geopolitical risks are potentially offset by high forex reserves, moderate fiscal balance and healthy balance sheets of Indian Banks and Corporates. India has also diversified amongst international partners for oil supply and exports, and therefore impact of such instances could be lower.
Numbers in Perspective
Source: Bloomberg, World Trade Organisation (April 2024)
Suez Canal Disruptions – key impact on India
- The Suez Canal is one of the top five busiest global marine routes; nearly 12% of the global trade flows happen through the Suez annually
- It reduces travel distance between India’s west coast and Europe by ~15 days vis-à-vis the Cape of Good Hope (South Africa) and results in significant savings on freight costs. Blockage of the Suez Canal increases time and fuel costs for trade between India and Europe, and other destinations such as the Americas.
- India has a significant share of trade via Europe – approximately 23% of its overall exports are to Europe.
Source: Economic Survey, Bloomberg
Potential and current impact on Oil prices and supply to India
Global dependence on Middle Eastern oil remains high (~30%) with India importing ~40% of its crude oil from ME. Increasingly, India has been importing Russian oil. The Strait of Hormuz, the only sea passage from the Persian Gulf to the open oceans, is one of the world's most strategically important choke points with Iran to its north and Oman to its south. Movement of ships through the strait has been affected by conflict in the past, and is now at risk with Iran being a part of the conflict. Any disruption on this choke point could have significant implications for global oil prices and oil supply to India.
Diversification of export partners to offset trade risks
As per an analysis in the Economic Survey 2024, India is adding more export destinations, signalling regional diversification of exports. Share of the top 10 countries in India’s merchandise exports has declined from a high of 61.9 per cent in FY2000 to 50.5 per cent in FY24. Further, the Regional Herfindahl Index (an estimate of the concentration of exports across countries) for the top 10 countries declined from 0.071 in FY2000 to 0.046 in FY24. India’s improving foreign relationships and the China + 1 theme also continues to benefit Indian trade.
Conclusion
With the pandemic related disruptions in the supply chain, the world underwent a significant learning curve, and is better prepared for events such as the disruption in the Suez Canal. Therefore, despite disturbances in the Red Sea, availability of goods globally did not see a large impact. However, current situation has increased logistics costs and heightened risks to trade growth. Significant escalation with blockades across key routes such as the Strait of Hormuz could further add to prevailing uncertainty. With no imminent resolutions in sight, markets are pricing in higher oil prices which remains a key macroeconomic risk for India’s current account balance, fiscal balance and inflation.
In terms of risks, India is relatively well placed:
- Forex reserves at US$700bn now cover approximately 11.9 months of imports.
- The overall exports mix has significant contribution from the Services sector, especially software services exports which are relatively unaffected by supply chain disruptions.
- With increasing diversification in our energy needs, India is incrementally reducing its reliance on imported oil.
While we remain watchful of increasing geopolitical risks, India’s cautioned approach to fiscal spending and low leverage across the economy potentially reduces significant macroeconomic risks.
Sources: Bloomberg, Economic Survey, ICRA, PIB, and other publicly available information
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