US sanction against Iran: Implications for the Indian Economy

The global crude oil market is passing through a critical stage with the US sanctions against Iran completely coming into effect. Recently, the US decided to end sanction waivers to the eight major oil-importing economies including India to buy crude oil from Iran. The sanctions, aimed at bringing down Iran’s oil export to zero, could have a major impact on global crude oil prices. This, along with OPEC’s decision to cut production, is going to bring a difficult situation in the crude oil market, especially for the crude importing economies.

Importance of Iran in the oil market

Among the OPEC countries, Iran is the fourth largest exporter of crude oil having a share of around 9 percent in the total crude oil export of OPEC. In terms of crude production, Iran stands at the third position among the OPEC countries with a share of around 12 percent. The US sanctions against Iran would lead to demand-supply mismatch, bringing pressure on the crude oil prices.

Impact on Indian Economy

India is a major importer of crude oil with around 80 percent of its crude oil demand met through imports. In 2018-19, India imported USD 141081.6 million worth of crude oil registering a growth rate of around 30 percent from the previous fiscal year. Iran is one of the major suppliers of crude oil to India accounting for around 9 percent of the total crude imports. As per the Wood Mackenzie report, the two trillion economy is expected to outpace China in terms of the increasing oil demand. It shows that there is a pressing demand to fill the gap that will be left by Iran’s crude oil supply.

The high crude oil prices could also negatively affect the prospects of the Indian economy crippled with lower growth rates. The crude oil prices exert great influence in determining the price of other commodities. Higher crude price could push up the price of other essential commodities, and the economy would experience a higher inflation level. In such a scenario, RBI would have to withdraw from its rate-cutting spree. Even if the Central Bank goes for a rate cut in June, it might hold the rate in its August meeting.

The rising crude oil price would also reflect in the exchange rate with rupee expected to depreciate against the dollar. The depreciation of the rupee would not go well with importers, as it could increase the overall cost of production. It needs to be looked to what extent the exporters will benefit, with the global economy poised to slow down in 2019-20. India would also need more dollars to pay for the increased crude bill, as the rupee payment mechanism with Iran cannot be availed with other countries.

The country has benefitted from the low crude oil prices, and was able to control and reduce the current account deficit (CAD) as a percent of GDP from -4.31 percent in 2011-12 to -1.84 percent in 2017-18. If the present scenario sustains, rising crude oil price would widen the CAD to an uncomfortable level. Furthermore, if the newly elected government is not successful in meeting the fiscal deficit target, the country would be again pushed into the twin-deficit problem.

Deepthi Mary Mathew
Economist, Geojit Financial Services Ltd.