Israel-Palestine War: 4 ways the battle may hurt Indian economy

By Team Newsable | First Published Oct 14, 2023, 6:26 PM IST

Amid global tensions, India's booming economy faces potential challenges. Barclays Vice President Shishu Ranjan analyses how the Israel-Palestine war may impact India's economic growth

There is no end to the long tunnel through which the world economy has been passing since the Coronavirus-triggered recession. The Russia-Ukraine war pushed the world economy on edge with extended pressure on the supply chain that resulted in very high inflation (7-9%) in developed economies and forced the central banks, especially the Federal Reserve, to raise the interest rate. That move is creating an affordability crisis for middle and lower-income group people. When the world economy somehow learnt the art of isolating war impact on supply chain management, another war started in West Asia, which has the potential to disrupt world trade and economy as this war could quickly escalate between major oil producers on one side and developed western countries on the other side.

Thankfully, India navigated the stormy waters and emerged as the fastest-growing economy for the last 2 years and is expected to hold its position for the entire decade. The Reserve Bank mitigated the inflationary pressure by increasing the interest rate and the government acted swiftly to negotiate a favourable oil trade deal with Russia that helped India to keep the fuel prices in check.

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With the success of the G20 summit in New Delhi, India is bullish on attracting FDI and FIIs, which are significant growth drivers for the Indian economy. However, one more war and that too in West Asia has the potential to impact the Indian economy in multiple ways.

First, the India-Middle East-Europe Economic Corridor (IMEEC) announced as part of the G20 summit seems to be in limbo as it is supposed to be passing through the United Arab Emirates, Saudi Arabia, Israel and Jordan. With war, priority changes and so do the allies. Though Saudis and Israel were negotiating a peace deal, it is difficult to sail through in a currently charged environment. This economic corridor is supposed to boost trade by utilising a multi-modal transportation system and is expected to reduce transportation costs, thus lowering the prices and helping various economies to lower their inflation. Since India is investing heavily in manufacturing capabilities, the corridor was supposed to be an engine of exports to West Asian and European countries.

Second, the war is going to impact India’s trade with Israel. In 2022, India exported goods worth $8 billion and imported goods worth $2.3 billion. India’s imports are strategic in nature as it is dominated by goods used for defence purposes and Israel at war can’t be expected to continue with exports of similar magnitude. Similarly, war will divert Israel's funds towards most critical requirements and that is expected to reduce imports of non-essential items.

Third, the inflation rates have shown an upward movement since the last quarter and are above the upper boundary of the targeted inflation rate (6 per cent). Given Iran has helped the terrorists to attack Israel and if Israel retaliates at a later stage, it would adversely impact India’s economic interest as Iran is a major oil producer. If Saudi Arabia is also pulled into this war, Indian import of crude oil would be severely affected as Saudi Arabia is the fourth largest supplier for India. Such a scenario would push the oil rates high and inflationary pressure on India’s economy would be difficult to mitigate. The interest rates are already high at 6.5 per cent and any further increase would hurt the investments as higher inflation would increase the capital cost as well as reduce the purchasing power capacity of the people, thereby curbing the general demand in the economy.

Fourth, the war uncertainties will impact the foreign exchange market due to which there will be two impacts. One, Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) would be reduced and it has been evident in crashing the market since this news came out. The United States, the largest investor in India, has come out in full support of Israel and therefore, their funds are diverted to Israeli aid. Even before this war erupted, October 2023 witnessed the sale of Rs 4000 crore offloading of FIIs. Two, the Indian currency may depreciate further causing inflation risk and aiding in the flight of capital.

Amid uncertainties during the course of the war, India is still in an advantageous position because general investment sentiments are good. India is focusing on creating manufacturing capacity and the Western developed market is favourable to India due to geopolitical reasons. Several FTA agreements have shaped up and that provides the cushion from minor shocks in international order. Only time will tell how easy or difficult this war would be for a bullish Indian economy.

The author is Vice President-Independent Validation Unit (Model Risk) at Barclays. Views expressed are personal.

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