The escalating Iran-Israel conflict (which now includes strikes by the United States and other large-scale military operations) has created major risks for India's oil-dependent economy and its increasingly volatile stock markets, with Brent crude now above $100/barrel due to supply concerns through the Straits of Hormuz.
As a result, Indian investors are likely to experience a number of negative impacts, including:
(1) higher levels of inflation
(2) a weaker rupee
(3) greater pressure on specific sectors of the economy.
This guide outlines the macroeconomic linkages connecting these developments and provides information on a number of practical strategies that retail investors can implement to deal with this uncertainty.
Current Conflict Status
The United States and Israel have carried out hundreds of airstrikes on targets in Iran, focusing on locations such as Tehran, IRGC bases, and Iranian nuclear sites. These military actions were in retaliation for the death of Ali Khamenei, Iran’s Supreme Leader. Iran responded to these attacks with its own airstrikes, mainly on extremely populated civilian centers, along with US troop deployments. Over 50,000 troops and troop transport vessels have now been mobilised into what US President Donald Trump has warned will be a long conflict.
As a result of these military escalations, crude oil prices have risen sharply (between 20-35%) recently, reaching new record highs in 2022 before experiencing partial pullbacks. These oil price increases will be further compounded by supply risks from OPEC member nations in the Middle East. Global equity markets have reflected this heightened level of panic, as massive amounts of capital continue to flow from Silicon Valley into gold and US dollar-denominated assets, therefore further inflating the stress levels on existing emerging market assets.
Economic Impacts on India
Imports of crude oil account for 85% of crude oil supplies to India; thus, any Middle Eastern oil supply disruptions will create significant risks for India's economy. For example, a $10 barrel increase in crude oil prices would reduce GDP growth by approximately 0.3% and increase inflation by about 0.4%. The CPI has recently decreased to the lowest level in the last 75 months.
The increase in crude oil imports leads to a larger current account deficit, which puts downward pressure on the value of the rupee (89.98 USD: INR). The rupee's continued depreciation is anticipated due in part to capital outflows by foreign institutional investors (FIIs) as well as global risk-off sentiment. Trade with Iran ($2.31B) will be lower during 2024, but trade will remain unstable and may reverse direction. Trade with Iran is down 2.34% YOY thus far.
Disruptions in shipping and increases in logistics costs will create price increases for fuel (petrol, diesel, LPG), as well as increased transportation costs for all commodities (including rice). To put it simply, household budgets will face increased expenses from higher fuel prices, while corporate profits will suffer due to increased transportation costs associated with rising fuel prices.
Stock Market Reactions
Indices have crashed: Sensex plummets 2,368 points to 78,919; Nifty 50 down 729 points to 24,450 over the past week; loss of approximately Rs 9.7 lakh crores in value created by FII selling (investors). As Indian equity underperforms globally, augmented price shocks to oil prices (Goldman Sachs).
Geopolitical risk is negatively correlated to FII inflows, resulting in volatile price behaviour similar to historical examples (e.g., Russia-Ukraine). The markets are susceptible to difficulty related to upcoming news events,s causing an increasing decline in indices.
Defensives like FMCG, healthcare, and IT may see rotation inflows during uncertainty.
Investor Strategies Amid Volatility
Diversify aggressively; invest in gold, US, cash equivalents, for stable investments, and in Upstream Energy and Defence for tactical opportunities. Do not overreact to price dips - historical wars have not stalled India's growth. Use price corrections to slowly add to quality stocks (strong earnings).
Maintain 20-30% in cash equivalents for buying opportunities, use Gold ETFs to hedge, and keep an eye on the Rupee and RBI intervention. Over the long term, India's diversification of its import sources (Libya, the US, and Brazil) will provide greater resiliency and less reliance on Russia and the Middle East.
Continue monitoring oil prices above $100/bbl and the Strait of Hormuz as potential market-changers; therefore, if high prices continue for prolonged periods, rotate sectors as opposed to chasing broad rallies. Use strategies such as SIPs in diversified funds to shield yourself from market volatility.
Opportunities in Uncertainty
The defence stocks (HAL, BEL) could see rises in value due to the expected global surge in military spending, and ONGC will also see gains from the higher prices of crude oil. Meanwhile, gold will shine as a safe-haven investment, while FII's are fleeing from the stock market.
India's domestic infrastructure and manufacturing capex are providing a buffer against instability, so long-term funds will continue to flow into India, despite the short-term pain of volatility in the market. Using proactive risk monitoring will enable knowledgeable investors to create alpha from risk.
*The article is for information purposes only. This is not investment advice.
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