Israel-Hamas war and India economy: Even as the world grapples with the shocks of ongoing wars, the state of the Indian economy looks promising, according to the RBI. However, high inflation still remains a major risk to macroeconomic stability and sustainable growth and the latest escalation between Israel and Hamas may unravel the hard work done so far by the apex bank towards keeping inflation in check.
In its recent MPC meeting held last week, the Reserve Bank of India (RBI) kept the benchmark interest rate unchanged at 6.50% which was in line with expectations. The major goal of the apex bank remains taming inflation which has been above the RBI’s upper tolerance limit of 6%. The government’s current focus will be keeping liquidity tight using bond sales to bring inflation closer to its 4% target, RBI said in its bi-monthly monetary policy review.
The Indian economy is showing resilience on the back of strong demand. A steady expansion is being seen in urban consumption whereas rural consumption is also showing signs of revival.
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Israel-Hamas war and India
While the Reserve Bank is optimistic of India’s future prospects, it is notable that the MPC meet was held before escalations in Israel-Palestine conflict which is bound to have repercussions to the global economy as well as India. For instance, crude oil prices surged sharply on Monday as the tensions escalated in the Middle East, which is home to almost a third of global oil supply. Brent crude rose 3.44% to $87.49 a barrel. The surge in oil prices will be even sharper if the crisis spreads to other countries in the region which could develop into a more devastating proxy war.
India can get affected if the price remains high due to further supply disruptions, considering India imports nearly 80% of its oil needs. Higher crude oil will distort the country’s balance of trade and CAD thus putting pressure on the rupee.
A jump in crude oil prices also further threatens high inflation and India being a big importer of oil can see high imported inflation if the oil prices remain elevated. When oil prices rise, the cost of production for various industries and energy costs for businesses and households also surge, driving inflation higher. A combination of high energy prices and new inflationary trends has the potential to undermine the central bank’s efforts to bring inflation under control. This can see interest rates at an elevated level for a prolonged period.
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India is also a trading partner of Israel and the recent activities do not have any immediate impact. However, it can create supply-side problems if the conflict escalates. India’s exports to Israel account for 1.8% of India’s total merchandise exports led by petroleum products. Israel buys around $5.5-6 billion of refined petroleum products from India. In FY23, India’s total exports to Israel stood at $8.4 billion. On the other hand, India imports machinery, pearls, diamonds and other precious and semi-precious stones from Israel. In FY23, India’s imports from Israel were at $2.3 billion.
RBI’s MPC meet took place before the Israel-Palestine conflict and the central Bank couldn’t have accounted for the effects of the same on inflation. Consequently, the apex bank kept its retail inflation forecast to 5.4% for the financial year ending March 2024, while asserting that headline inflation could remain high for a longer than estimated time.
The headline CPI projection for FY24 remains unchanged at 5.4%. This is despite growing uncertainties around production due to the lower kharif sowing, low reservoir levels, and volatile global food and energy prices. The momentum in agricultural activity in Q2 of the current financial year has been sustained, although the monsoon has been uneven. Good reports are also pouring in from the manufacturing sector which gained ground in July-August 2023, supported by key sectors such as pharmaceuticals, basic metals, cement, motor vehicles, and food products and beverages. The purchasing managers’ index (PMI) for manufacturing also remained robust in September.
Going forward, domestic demand conditions are likely to benefit from sustained buoyancy in services, consumer and business optimism, and the government’s continued thrust on capex. Other than this, healthy balance sheets of banks and corporates, and supply chain normalisation are also helping matters for the economy, Governor Das said.
Overall, there is no denying the fact that the global economy is slowing under the impact of tight financial conditions, protracted geopolitical tensions and increasing geoeconomic fragmentation. Since global trade is contracting, that may have an impact on the economy.
Over the last one and half years, the RBI has increased policy repo rate by 250 basis points with the view to break the stickiness of core inflation. Real GDP growth for the current financial year (FY24) is projected at 6.5% with quarter two at 6.5%; quarter three at 6% and quarter four at 5.7%. RBI has also projected GDP growth for the first quarter of next financial year i.e, FY25 at 6.6%.