Will Escalation in the Middle East Harm the Indian Economy?

Iran is nearer to India. Oil imports from the Middle East are quite critical for the Indian economy.

Image used for representation only.

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The Israel-Hamas war completes one year today without either side achieving its objectives. The war has now engulfed Lebanon as well. Israel has, besides pounding Beirut and South Lebanon with missiles and bombs, killed Hezbollah's chief and other key operatives.

Iran jumped into the fray and launched more than 200 missiles at Israel, with some reaching their targets. Israel has promised to retaliate at the time of its choosing. There are serious apprehensions that Israel may successfully hit Iran’s oil and nuclear facilities.

Compared to Israel, Iran is closer to India. Oil imports from the Middle East are quite critical for the Indian economy. Millions of Indian labourers work in the region and send billions of dollars in remittances.

If the tensions escalate into a full-blown Israel-Iran war, how much is the Indian economy likely to be impacted?

Oil

Globally, Iran produces a little less than three percent of crude oil and exports about two percent of global oil consumption. Most of it is currently exported to China, Vietnam, and other countries in East Asia. India hardly imports any crude oil from Iran, having gradually wound down imports after the hardening of US sanctions on Iran by the Trump administration.

If Israel were to succeed in damaging Iran’s oil facilities and putting Iranian oil out of supply completely (highly unlikely although some damage possible), the global supply of crude oil (about 100 million barrels a day) would still not be dramatically reduced. However, Iran's reaction might disrupt the Persian Gulf (for some time at least), putting enormous strain on the crude oil supplies from Saudi Arabia, Iraq, Kuwait and other countries.

This will most likely upend the oil markets and oil supply for some time as had happened during the early phase of the Ukraine-Russia war, until the global supply chains get reconfigured and normalised. Oil and gas prices may also witness a major uptick.

India, dependent for more than 80 percent of its petroleum and gas consumption on imports, will definitely feel the pinch in such a case. How long would such a situation last is difficult to say.

At the moment, the oil markets are not factoring in the possibility of Israel successfully putting Iran’s oil facilities out of use and are, therefore, not too worried. The spot prices have recently gone up from $70 a barrel to $75-78 a barrel. The future prices do not show any significant volatility and instability either.

India may not worry too much on this front. If push comes to shove, India has the option of increasing its oil imports from Russia and South America.

Gulf Labour and Remittances 

Not many Indians work in Iran. A very large Indian labour force (about nine million workers), however, is present in the Gulf countries, concentrated in the UAE (3.5 million) Saudi Arabia (2.5 million), Kuwait and Qatar (about one million each) and Oman (0.6 million).

Hardly any Indian immigrant worker has returned from the Gulf after the Israel-Hamas war broke out. In fact, thousands of Indian workers queued up to go to even Israel to replace other workers who left.

There is no let-up in the remittances inflows. In 2023, India received a total of $120 billion (World Bank Report) in remittances. Given that historically, 30 percent of remittances have been flowing from the Gulf countries, India must have received about 35$ billion from the Gulf (actual country-wide data has a lag). There is no perceptible impact seen in 2024.

In the past, India has faced significant challenges in some of the Middle Eastern conflicts. We had to evacuate lakhs of workers from Kuwait in 1990 (estimated 1.7 lakh by Air India alone) when Iraq invaded it. Hardly any evacuation, however, had to be done when the US invaded Iraq in 2003.

As there is hardly any presence of Indian workers in Iran, it is unlikely that India will face any contingency of evacuating the Indian labour force in case Israel pounds Iran. Indian workers are intrepid. There might actually be a higher demand for Indian workers in the Middle East if the conflict were to become wider.

Exchange Rate

Inflation has been brought significantly under control in the US and Europe. The economically advanced countries have begun cutting rates, with the US Fed delivering an unexpectedly high 50 basis points cut last month.

The US dollar had begun weakening in August-September. However, with the rising possibility of the Israel-Iran conflict, the dollar has again started strengthening.

Most of the global currencies have strengthened against the US dollar. The Indian Rupee, despite India having a huge stockpile of $700 billion in foreign exchange assets, is as of now, about 0.75 percent down against the US dollar in the 2024-25 year.

The strengthening dollar, coupled with Chinese stocks becoming red hot following the unprecedented stimulus package launched by the government and the central bank, has made foreign portfolio investors (FPIs) turn big sellers in Indian equities in the last couple of days.

The rupee exchange rate may be more influenced by how the RBI deals with its instinct to pile up the ever-higher foreign exchange reserves and by FPI behaviour, and not by the Israel-Hamas war escalating into an Israel-Iran one.

Trade and Investment

The sea routes of the Gulf and the Red Sea-Suez Canal are very important for India’s trade with the Middle East and Europe.

For various reasons, including the Yemeni militia attacks, the Red Sea-Suez Canal route has seen off-and-on disruptions, resulting in the hardening of freight and insurance rates. Trade in the Middle East has also witnessed some disruptions on account of escalating tensions and, if Israel bombs Iran, these disruptions will get aggravated.

These developments have already put Indian exports to the Middle East at a heightened risk and any further escalation will certainly result in a squeeze on our exports.

India does not receive a lot foreign direct investment (FDI) from the Middle East barring the UAE and Saudi Arabia to some extent. FDI is a long-term investment game and is not affected by short-term conflicts.

Global FDI investments may not have suffered the impact of the war and are unlikely to despite the widening conflict. Likewise, investment in Indian start-ups is also unlikely to be affected.

Overall Risk to the Indian Economy Seems Small

The leading economies of the world, ie, the US, Europe, and China, controlling about two-thirds of the global GDP and four-fifths of global wealth, have too much of a stake and might tolerate a limited conflict between Iran and Israel.

Israel’s principal aim is to subsume Gaza and the West Bank into its own territory. Widening the conflict with Iran does not help in attaining that objective. Neutralising Iran to the extent that it does not prop up Hamas and Hezbollah serves its purpose.

The chances of Israel being allowed to or actually intending to hit Iran’s nuclear installations are quite low (some oil facilities, yes). What does Israel gain by targeting nuclear installations? Some damage to the oil facilities in Iran would secure enough brownie points.

Putting it all together, the risk to the Indian economy seems quite small.

(The author is former Economic Affairs Secretary and former Finance Secretary of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)