The US-Iran war has brought back memories of the past gigantic oil shocks of the 1970s and the Gulf War era. The most visible indicator is a sharp spike in global crude oil prices. However, underneath the oil price headlines lie panicky markets, vulnerability of integrated supply chains, and a plausible threat of global inflation.

Despite efforts towards green energy transition, oil and other fossil fuels statistically remain important inputs in the global production chain. With the fights escalating and key shipping routes, including the Strait of Hormuz, coming under threat or disruption, crude prices have soared.

Prices breached the psychological USD 100 per barrel mark on March 8, before going down again below USD 88 per barrel after news of the International Energy Agency (IEA) report for oil reserve release broke in the media.

Stock markets all over the world are bleeding, and Indian markets are no exception. Daily traders are not only reacting to actual supply disruptions but also to the continued risk of tankers passing through chokepoints. As more infrastructure around the war zone is targeted, there is a possibility that some oil producers will deliberately hold back output to minimise risk.

In a nutshell, a significant “war premium” has been added to every barrel of oil that moves across the world. Though physical supply is not yet severely constrained, insurance costs have jumped, shipping rates have climbed, and futures markets are showing anxiety. The combination is potent enough to send a powerful inflationary signal across the global economy.

For India, this is a clear and present danger. As one of the world’s largest importers of crude, India is structurally exposed. Any increase in crude price inflates the country’s import bill and jeopardises its terms of trade. More so when that increase is sudden and substantial.

Eventually, it can quickly translate into a wider current account deficit, pressure on the rupee and more difficult choices for policymakers trying to balance growth, inflation and external stability.

Heightened crude oil prices will have an immediate impact on the Indian economy. Transport costs rise, from urban commuting to the movement of food and manufactured goods. Fertiliser and petrochemical prices climb, raising input costs for farmers and industry. Airlines, logistics firms, cement producers and other energy-intensive sectors experience margins squeezed, and some of these higher costs inevitably would get passed on to consumers.

Even if retail petrol and diesel prices at the pump are temporarily kept stable, that does not make the problem disappear; it merely shifts the burden.

Stabilising oil retail prices may be initially done via state-owned oil enterprises. If these firms sell fuel below cost, losses are bound to reflect on their balance sheets until the government compensates them or allows price hikes.

Alternatively, the central and state governments can reduce fuel taxes to cushion consumers. However, that would immediately shrink their respective fiscal spaces. The effect of the shock does not go away but crops up somewhere in the system – in company finances, public accounts, or ultimately in the purse strings of households and businesses.

The timing of the war for financial markets is equally bad. Before the war, investors were hoping for a world of slower but still positive growth, gentle inflation, and the prospect of interest rate cuts across major economies.

The war has dashed that optimism in a single stroke. All major stock markets in the world crashed as investors scrambled to reassess earnings forecasts, risk premia and eventually the possibility of a rate hike. The result is simple – sell-off. And that sell-off has been particularly acute in emerging economies, like India, which are large net energy importers. Indian equity markets were earlier supported by domestic growth optimism of the retail investors, but the war has halted that optimism.

The current stock market crash is an indication that vulnerabilities are getting repriced in the near-term macro-outlook. Cyclical and energy-intensive sectors have borne the maximum brunt of this repricing.

Beyond the inflation horizon, the conflict is seriously affecting global trade. In times of war, ships take different and longer routes, insurance underwriters are more cautious, and trade finance gets costlier.

Oil tankers are already redirected around longer routes like the Cape of Good Hope, adding to time and costs. Result: Some exporters may pause production. Importers, in turn, scramble to diversify suppliers.

These adjustments are not limited to crude oil. A wide range of other energy-intensive and petrochemical-based supply chains in a range of sectors – from fertilisers and plastics to synthetic fibres and industrial chemicals – will be affected due to the lack of cheap and predictable oil and gas.

When the global manufacturing foundation is shaken, costs rise across the board, pushing up prices even in sectors like food, apparel, electronics and countless other goods.

So, the resultant inflation can be overwhelming. Central banks of the world spent the last two years trying to drag inflation back; this shock has undone their efforts. The longer crude stays elevated, the greater the risk that higher prices become embedded in future expectations and wage demands.

That are the classic makings of a mild stagflation: much slower growth, but inflation that refuses to fall as quickly as expected. In such a world, the monetary policy may have to be rearranged.

Do central banks prioritise supporting activity in the face of a geopolitical shock, or do they hold rates higher for longer to contain subsequent second-round inflation? The trade-offs will differ by country and will be decided by the corresponding political economy.

In a country like India, with more limited policy space and greater sensitivity to external financing, those trade-offs are particularly perilous and uncertain.

Hope of a swift de-escalation, credible protection of key shipping routes, and coordinated action by major producers and consumers can calm markets, but nobody can be sure of that. A prolonged or widening conflict would aggravate today’s panic into a more durable economic slump.

The US–Iran war has exposed the fragility of a world so tightly bound to fossil fuel flows from a volatile geographical region. Energy security, macro stability and geopolitical risk have all rolled into a single story. India uncomfortably finds itself staring at it, despite growing admirably in the last couple of years.

(Author is a senior economist with Chintan Research Foundation. Views are personal)

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‘Deplores targeting of commercial ships,’ says India after Iran attacks Gujarat-bound Thai ship in Strait of Hormuz

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