Fallout of War, How India Must Prepare to Minimize the Damage from a Prolonged West Asia Conflict

Fallout of War, How India Must Prepare to Minimize the Damage from a Prolonged West Asia Conflict

United States President Donald Trump’s statement on Monday, announcing a five-day pause on military strikes targeting Iranian energy infrastructure, raised fleeting hopes of a possible end to hostilities in West Asia. Markets reacted positively, for a moment, to the possibility of de-escalation. But the hope did not last long. Iranian officials quickly made it clear that they were not negotiating with the US. While reports indicate that countries like Pakistan, Türkiye, and Egypt are talking to both sides to find a resolution, the path to peace remains unclear. As things stand, the war is in its fourth week, and there is no end in sight. Iran has suffered substantial damage, but it has held its ground and is unwilling to compromise. Further attacks on energy infrastructure, as both sides have threatened, could lead to lasting and catastrophic consequences.

The impact of this conflict is already being felt across the globe, and India is no exception. The channels of transmission are multiple and complex, and while macro indicators may not yet capture the full picture, the damage is accumulating beneath the surface. The war is now in its fourth week, and its effects are becoming visible in ways that are harder to quantify but no less real.

One of the most immediate and visible impacts has been on the supply of different varieties of gas. The government rightly decided to prioritize household needs over industrial use, ensuring that kitchens across the country continue to function. But this decision comes at a significant cost for businesses. There are reports that workers in industrial areas are moving back to their villages, unable to find employment as factories scale down or shut down due to gas shortages. Though the problem is not exactly comparable to the COVID-19 pandemic, which was a far larger and more systemic crisis, the closure of small businesses could lead to permanent output loss with possible medium-term implications. A small unit that closes today may not reopen tomorrow. The machinery may be sold, the workers may disperse, and the supply chain may be broken beyond repair. At this stage, it is hard to assess the loss of output and its impact on employment. But if the war does not end soon, both analysts and policymakers will have to start incorporating these factors into their analysis.

West Asia is not only a source of petroleum imports for India; it is also an important export destination for Indian goods. In 2024-25, India exported goods worth about $57 billion to the countries of the Gulf Cooperation Council (GCC). This trade, too, is now under threat. A prolonged crisis will disrupt shipping, increase insurance costs, and dampen demand in the region. Exporters who rely on these markets will see their orders shrink, their cash flows strained, and their businesses threatened. The $57 billion figure is not just a statistic; it represents the livelihoods of countless traders, manufacturers, and workers across India.

Beyond the immediate impact on output and trade, a prolonged war will create significant challenges for macroeconomic management. On the fiscal front, the government has thus far decided to selectively pass on the increase in the prices of crude oil and gas to consumers. This means that oil marketing companies are absorbing a significant portion of the price shock, which will result in lower dividend payments to the government. These companies are public sector undertakings; their profits are a source of government revenue. When they lose money, the government loses revenue. In addition, the government may have to compensate oil companies for under-recoveries on retail sales, adding to the fiscal burden. A loss of output in general would affect both direct and indirect tax collection. If businesses are closing and workers are unemployed, the tax base shrinks. The government recently announced an economic stabilization fund of ₹1 trillion, though it is unclear when and how it will be used. It may also have to allocate substantially more for fertilizer subsidies, as farmers face higher input costs. All of these pressures will widen the fiscal deficit, which was already stretched.

Although higher energy prices have been selectively passed on, they will inevitably push up the inflation rate. Lower production due to gas shortages in different areas will also be reflected in higher prices. The impact will not be uniform; some sectors will be hit harder than others. But the overall direction is clear: inflation is set to rise. Economists at the Reserve Bank of India (RBI) argued in its latest monthly bulletin that the situation requires close monitoring. The central bank’s full assessment will be known after the next meeting of the Monetary Policy Committee, scheduled for April 6-8. The challenge for the RBI will be to balance the need to control inflation with the need to support growth. Raising interest rates too aggressively could choke off an already fragile recovery; moving too slowly could allow inflation expectations to become unanchored.

The RBI’s immediate challenge, however, is to manage the external sector. India is currently running a deficit on the balance of payments, and the data on foreign direct investment (FDI) and foreign portfolio investment (FPI) is not encouraging. Foreign investors are becoming more cautious, and capital flows have slowed. Higher prices of oil will almost certainly increase the current account deficit (CAD) from the estimated 1 per cent of GDP for 2025-26. Every $10 increase in the price of oil adds roughly $13-14 billion to India’s import bill. At current prices, the increase is far larger. Financing a higher CAD could be challenging in the current global environment, where risk aversion is rising and liquidity is tightening.

The government and the central bank have a range of tools at their disposal. They can draw down foreign exchange reserves, which remain substantial. They can encourage more foreign investment by easing restrictions and improving the ease of doing business. They can seek to diversify sources of energy imports, reducing dependence on the Gulf region. They can accelerate the transition to renewable energy, reducing the economy’s overall dependence on imported fossil fuels. But all of these measures take time. The immediate task is to manage the crisis as it unfolds, to prevent a temporary shock from turning into a permanent loss.

The war in West Asia is a crisis that India did not create and cannot control. But it can control its response. The government and the central bank must coordinate closely, sharing information, aligning policies, and preparing a comprehensive response to minimize the damage and preserve macroeconomic stability. The next few weeks will be critical. The five-day pause announced by Trump is a pause, not a peace. The war could resume at any moment. India must be prepared for the worst while hoping for the best. It must also learn the lessons of this crisis. Dependence on imported energy is a structural vulnerability that cannot be fixed overnight, but it can be addressed over time. The current crisis is a reminder that energy security is national security, and that the cost of inaction is far higher than the cost of reform.

Questions and Answers

Q1: What was the market reaction to Trump’s five-day pause announcement, and why did the hope not last?

A1: Markets reacted positively to the announcement of a five-day pause on strikes targeting Iranian energy infrastructure, raising hopes of a possible end to hostilities. However, the hope did not last because Iranian officials quickly stated they were not negotiating with the US, and the path to peace remains unclear.

Q2: How is the war affecting Indian businesses beyond the direct impact of oil prices?

A2: The government’s decision to prioritize household needs for gas has led to shortages for industrial use. There are reports of workers in industrial areas moving back to their villages as factories scale down or shut down. The closure of small businesses could lead to permanent output loss with medium-term implications, as units may not reopen and supply chains may be broken.

Q3: What is the potential impact on India’s exports to the Gulf region?

A3: In 2024-25, India exported goods worth about $57 billion to GCC countries. A prolonged war will disrupt shipping, increase insurance costs, and dampen demand in the region, threatening the livelihoods of countless traders, manufacturers, and workers who depend on these exports.

Q4: What are the fiscal challenges facing the government due to the war?

A4: The government faces multiple fiscal challenges:

1. Oil marketing companies absorbing price shocks will lead to lower dividend payments to the government.

2. The government may have to compensate oil companies for under-recoveries on retail sales.

3. Loss of output will reduce direct and indirect tax collections.

4. The government may need to allocate more for fertilizer subsidies.
   All of these pressures will widen the fiscal deficit.

Q5: What is the RBI’s immediate challenge regarding the external sector?

A5: The RBI’s immediate challenge is managing the external sector. India is running a balance of payments deficit, and FDI and FPI flows are slowing. Higher oil prices will increase the current account deficit (CAD) from the estimated 1% of GDP for 2025-26. Financing a higher CAD could be challenging in the current global environment of rising risk aversion and tightening liquidity.