Israel-Hamas war: Inflation could be on the horizon if the crisis in Middle East persists

Even as the world was making peace with the Russia-Ukraine conflict, and the global economy showing signs of recovery, the Israel-Hamas war has opened up new worries. The Ukraine war has resulted in a sharp rise in crude oil and commodity prices, further slowing the growth of the world economy.

The International Monetary Fund’s (IMF) World Economic Outlook Update, that released recently, says forces, including the long-term consequences of the Covid-19 pandemic, the war in Ukraine, and increasing geo-economic fragmentation are holding back the recovery. It predicts the global economy to grow at 3 per cent in 2023, which could slow to 2.9 per cent in 2024.

The economic repercussions of the Israel-Hamas war are still playing out, but India is unlikely to go unscathed. “The overall global economic conditions remain a concern. The world cannot manage two wars at once,” says N.R. Bhanumurthy, Vice Chancellor of Dr. B.R. Ambedkar School of Economics University, Bengaluru, adding that any worsening of global economic conditions would impact the Indian economy.

For India, which has already been dealing with inflation, the Israel-Hamas war has brought fresh concerns. Finance Minister Nirmala Sitharaman, during her recent visit to Morroco to attend the IMF-World Bank Annual Meeting and G20 Finance Ministers and Central Bank Governors meeting, highlighted that the Middle Eastern crisis, fuel prices and fragmentation of global supply chains remain major concerns for emerging markets.

Experts as well as officials are worried about an escalation of the conflict or a long-drawn war, given that the Russia-Ukraine war has been raging for over 19 months now.

Petroleum and Natural Gas Minister Hardeep Singh Puri outlines three challenges for India—availability, affordability and sustainability. “As of now, we are not worried about the availability because the number of countries from which we import crude oil has increased from 27 to 39... As far as affordability is concerned, it is linked to availability. Prices can increase if the amount of oil available in the markets suddenly decreases. For sustainability, we have not diluted our situation in the green energy transition,” he notes.

As the third-largest importer of crude, any negative development in the Middle East could hurt the Indian economy in terms of higher inflation and the current account deficit, and also put the rupee under pressure. For FY24, the Reserve Bank of India has pegged crude prices at $85 a barrel, and an exchange rate of 82.5 against the US dollar. A 10 per cent jump in oil prices can make inflation soar by about 30 basis points and impact growth by about 15 basis points, says RBI.

Madan Sabnavis, Chief Economist of Bank of Baroda, says if the war persists, then the oil dynamics will change. “Brent had crossed the $90-mark, but then retreated. Now we can use the 90 number as the threshold, beyond which there is trouble for the world economy. India can get affected if the price remains high,” he says. Between March and September this year, Brent jumped by over 20 per cent. And, its effect can be seen on the prevailing high inflation. But, retail inflation can still be controlled if the government chooses to keep fuel prices unchanged, but wholesale inflation will surely increase, Sabnavis notes.

Retail inflation, which soared to a 14-month high in July, has now eased to 5.02 per cent in September, but worries over high cereal and pulses prices and the Israel crisis have made its trajectory uncertain. A silver lining for India has been that core inflation has remained under control; it was at 4.6 per cent in September. “Oil is the main story. A volatile oil price trajectory would affect our CAD, inflation and growth estimates,” says Madhavi Arora, Lead Economist of Emkay Global Financial Services. Since the Israel-Hamas conflict began, oil prices have surged 9.2 per cent, with Brent at $92.38 per barrel on October 19.

For now, Emkay has kept its estimate for the average Brent price for the fiscal at $85 per barrel. “We note at $90 per barrel, our CAD estimate will rise to 1.6 per cent [of the GDP], from the current 1.4 per cent; and our retail inflation forecast by 18-22 basis points to 5.4 per cent, while GDP growth could be hit by 10 basis points, ceteris paribus,” says Arora.

Experts note that on the trade front, the impact may be limited, even though India had a trade surplus of $6.1 billion with Israel last fiscal. A number of Indian firms also have investments in Israel, such as Indian Oil’s joint venture with Israeli start-up Phinergy; Sun Pharma’s subsidiary, Taro Pharmaceutical, among others. All these may feel the heat. Another possible impact could be on the roll-out of 5G networks and pharma exports.

What happens to the ambitious India-Middle East-Europe Economic Corridor also remains to be seen. But, Sitharaman said “it is a long-term plan and would not be impacted by short-term issues”. All eyes are on how countries in the Middle East deal with the conflict. “If the war drags on and spreads, it could have repercussions on global food and fuel prices, trade and transport costs,” warns Bhanumurthy. As for the government, this could mean choosing between increasing fuel prices ahead of upcoming elections, or letting the oil marketing companies suffer the losses. Both have their own costs.

@surabhi_prasad