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What the Iran-Israel conflict means for the Indian economy

15 Apr 2024 , 12:16 PM

IS IT A CONFLICT OR IS IT A FULL-FLEDGED WAR?

Just a few days back, Iran accused Israel of engineering an attack on the Iranian embassy in Syria, leading to military casualties. Then Iran responded with a barrage of rocket attacks on Israel, most of which were defended by Israel. Clearly, Iran and Israel are in conflict zone. Whether Israel responds to this provocation or whether Iran intensifies its attacks will determine whether this conflict turns into a full-fledged war or not. For now, Israel’s closest ally, the United States, has been trying to diffuse a war-like situation, but things could aggravate at any point of time. More importantly the definition of war has changed in recently years and it is not just about attacks and stand-offs on land, air, and water.

Today, war is fought on a number of fronts. There is cyber warfare which has become an important part of modern warfare, which is largely about data and communications. Israel has, for long, complemented its war efforts with economic blockades, US support via sanctions etc. The use of deep assets and deep intelligence in conducting war during peacetime is also well known. Iran, on the other hand, has largely relied on proxy wars. Iran has allegedly funded and armed rebels like the Houthis in Yemen, Hamas in Palestine, and the Hezbollah in Lebanon. These private armies have conducted a proxy war against states that have been inimical to Iran and the Arab world. The recent targeting of Red Sea vessels by the Yemeni Houthis is a case in point. In all likelihood, this may not be a full-fledged war, but attacks may continue in the near future.

HOW A WAR IMPACTS INDIA’S BUSINESS INTERESTS

Clearly, India has substantial business interests in both the countries, apart from having long diplomatic relationships with both these nations. Indian companies have several direct business interests in Israel. For example, Adani Ports is a joint owner and developer of the Haifa port in Israel, which is one of the busiest ports in the West Asian region. Port traffic normally gets deeply impacted by such war situations. Then there is the huge stake that Sun Pharma owns in Taro Pharma, a specialized generics player in the pharma space. Above all, in recent days, Reliance Industries has also expressed interest in buying out Tower Semiconductors of Israel, a key player in the fast-growing semiconductor segment. Indian companies are investing heavily in the semiconductor supply chain in recent months.

What about Iran. India is a major exporter of rice, tea, and raw sugar to Iran, apart from chemicals and pharmaceuticals. Of course, Iran is a key oil exporter and till 2019 Iran was among the largest exporters of oil to India. Post the sanctions in 2019, that has slowed, but it could pick up all over again. We will look at the oil economics separately. But the bigger concern is on the development of the Chabahar port in the Baluchistan province of Iran, which is being jointly developed by India and Iran. Once India gets access to the Chabahar Port in Iran, it will simplify and cut costs of trading with Iran and the Middle East. More importantly, it opens up a massively important trade route via road to Afghanistan, Armenia, Greece, Turkey and even Russia. It remains to be seen if it simplifies Russian oil trade with India. The truth is business interests are quite deep for India with Iran and Israel.

OIL REMAINS THE KEY FACTOR IN THE CONFLICT

There are several reasons why this conflict is likely to put further pressure on oil. Once it is full-fledged war, the tensions are only going to mount in the Red Sea region. That means, Houthi Rebels in Yemen would intensify attacks on ships passing through the Red Sea. So, ships coming from the US and Europe will have to take the much longer Horn of Africa route to India. That would imply delays in delivery schedules, higher freight costs due to the longer route and higher insurance premium due to longer routes and higher geopolitical risks. All these are likely to keep the price of Brent crude at elevated levels.

The other risk for India is that the theatre of war could expand. Currently, it is more like a conflict between Iran and Israel. However, it is unlikely that the Arab nations will remain bystanders if the conflict intensifies. They will have to take a stand, and public pressure will not allow them to take the side of Israel. That is when the war could actually spread to the Arab peninsula too. Now comes the bigger problem since India has strong trade links with the Middle East in terms of oil imports, trade, business interests and the presence of Indians in this region. Also, if the conflict intensifies, Iran could put added conditions on ships passing through the Straits of Hormuz, which is controlled by Iran. All these could worsen the trade situation for India.

HOW KEY SECTORS WILL BE IMPACTED BY THE CONFLICT

Obviously, the impact on Indian companies will be predominantly about oil, but it is also likely to extend beyond oil. Here are a few Indian sectors that would be impacted by a larger conflict in the Middle East / West Asia region.

  • The downstream oil is likely to be the one to be impacted. Higher oil prices would mean thinner marketing margins for the oil marketing companies (OMCs) like HPCL, BPCL and IOCL. The impact may vary depending on how much of a hedge you have through other businesses. However, the oil marketing companies are likely to see an impact.
  • Oil user industries will also see an impact. This is true of industries like tyres, paints, toiletries, and detergents that use crude oil as a key input. In this case, higher crude prices will translate into higher input costs for these companies. To the extent they cannot pass on the costs to the customer, it is likely to impact profit margins.
  • Capital goods companies are likely to see a slowdown in order execution in the GCC region. Companies like L&T have a very substantial franchise of EPC in the hydrocarbon projects in the GCC region. Any prolonged strife in the region will mean that the business flows and execution in the region gets impacted.
  • The one industry that will see a dual impact is the airline industry. Of course, higher crude prices will mean higher aviation turbine fuel (ATF) prices and that would narrow the gap between the RASK (revenue per average seat kilometre) and the CASK (cost per average seat kilometre). But there is a bigger impact. Airlines from India are already re-routing flights to avoid flying over Iranian and Israeli airspace. That could mean longer routes, and higher costs for airline companies.

The bottom line is that a host of industries are likely to be hit if the conflict spreads or if it intensifies in the coming days. It would not be good news for the Indian economy.

WILL THE WAR BE A BOOST FOR INDIAN DEFENCE INDUSTRY?

It is said that most wars are zero sum game. As Bertrand Russell put it, “War does not decide who is right; it only decides who is left.” While that may be a rather morbid definition of war, there is a lot of truth to it. However, the one industry that has globally gained from a state of war is the defence industry. Wars may not be great, but the fear of war is one of the best demand triggers for the defence industry. Already in the last few years, countries are increasingly looking to invest heavily in defence to be as self-sufficient as possible. How will Indian defence sector gain from the situation?

For FY24, India reported defence exports of ₹21,100 Crore. That is 32% higher than last year. But the difference in defence exports becomes starker when you look at a longer period. In the 10 years between FY05 to FY14, defence exports stood at ₹4,312 Crore. In FY24 alone, the defence exports is nearly 5-times the exports in those 10 years. Countries in the region are increasingly looking to India to support them with defence exports. The latest strife is likely to put the fear that the world is less safe today. That would push nations to spend more on defence and obviously, India would be a key port of call. If the strife continues, India’s defence could get a big boost in the coming months. This will be over and above the aggressive in-sourcing of defence needs that Indian defence forces are already doing. That could be happy times for the Indian defence companies.

BUT, INDIA WILL HAVE A DIPLOMATIC CHALLENGE

The one conflict that India may have to contend with is the diplomatic choices. In the last 10 years, India has not only built bridges with Israel but has also leveraged the Israeli expertise in defence, technology and in start-ups. With regard to the Middle East, India has become an important partner. The problem is that if the war effort intensifies, then India may have to take sides. That will not be a very comfortable situation to have. Of course, India can always the middle path or the neutral stance, but that is not yield dividends any longer. We saw that in the case of Russia wherein India adopted a neutral stance in the Russia Ukraine war, but despite India’s best efforts to assuage Russia, it is China that appears to be calling the shots with Russia. That is a problem for India to contend with if the war situation worsens. But that is something India can afford to worry about later!

Related Tags

  • BrentCrude
  • Crudeoil
  • Iran
  • Israel
  • MiddleEast
  • nifty
  • OilShock
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