The US-Israel war on Iran has entered the fourth week and the Indian benchmark indices are down by 8%. The first-order effects of the war are familiar to all of us, with the Strait of Hormuz effectively closed. Of India’s imports, roughly 54% of crude, 60% of LNG (liquefied natural gas) and as much as 90% of LPG (liquefied petroleum gas) transit through Hormuz. Along with oil and gas, India faces a shortage of refined products like naphtha, aviation turbine fuel and gasoil. The deeper vulnerability lies in food. Food production depends on diesel and fertiliser. Diesel runs tractors, irrigation pumps and the transport system that carries crops. Fertilisers—urea, ammonia and phosphates—determine yields. More than 30% of the global urea trade and roughly 20% of ammonia and phosphate pass through Hormuz.
The Gulf region is also a critical supplier of more than a third of global helium, a niche input indispensable for semiconductor and imaging machines. It accounts for around 30% of global methanol production, a base chemical for plastics, paints and fuels. It dominates sulphur exports—about 45% of the global total—which feeds directly into fertiliser production. Even aluminium is affected: the Gulf produces roughly 9% of global output and accounts for 22% of supply outside China, leaving Europe and America exposed in sectors from automotives to construction. Investors now have to decide how much of these effects are already priced in so far.
Consider aviation fuel which accounts for 35%–40% of the cost of running an airline. A 10% increase in fuel prices can cut operating profits by around 15%, according to analysts. Add to this the complication of West Asian airspace closures and longer flight paths and their margins erode further. In consumer goods, the pressure is more diffused. Crude-linked packaging materials—PET (polyethylene terephthalate) chips, liquid paraffin, HDPE (high density polyethylene) and flexible laminates—account for roughly 15% of operating costs, calculate analysts. Larger firms, with pricing power, can pass some of this on to customers; smaller, unorganised players cannot, accelerating a shift in market share. Glass production depends on natural gas. Textile producers rely on intermediates; disruptions have already pushed polyester yarn prices up by roughly 15%–20%. Cement avoids direct supply disruption but still suffers from price effects: an increase in fuel costs can reduce earnings, with an additional hit from higher polypropylene prices used in packaging. Tile producers in Morbi, Gujarat, have already shut down due to a lack of gas.
Each of these is a small cog. Together, they form a system that is bound to be affected by time and price. Over the past few weeks of shortages, very little has appeared amiss. But once inventories run down, in one to three months’ time, replenishment will come at sharply higher costs, triggering a bigger hidden shock. The question is: How much of this is priced in by the market? Markets react quickly to first-order shock—equities wobble, currencies weaken. By nature, optimistic, investors tend to assume that normality will return soon. The second- and third-order effects are less visible. The broader fiscal arithmetic and the effect on consumption are treated as secondary concerns.
Every US$10 rise in crude adds roughly US$12bn–US$15bn (billion) to India’s import bill. A sustained oil price above US$80 risks pushing inflation beyond 4.5%, widening the current-account deficit towards 1.5%–2% of GDP and weakening the rupee, potentially past 95 to the dollar. Capital inflows will slow down at a time the rupee is weakening and foreign portfolio investors are already exiting. Out of US$130bn–US$135bn in annual remittances India gets, some US$45bn–US$50bn come from the Gulf. Even a 10% decline would shave off inflows of US$4bn–US$5bn.
The biggest impact will be a worsening trade balance, higher inflation, widening fiscal deficit and lower tax revenues. Higher fertiliser costs raise subsidy bills; shortages risk lower application by farmers, which in turn threatens yields. Governments can absorb some increase in fuel prices, but absorbing both fuel and fertiliser shocks is harder. At oil prices of above US$100, the fiscal cost of subsidies and tax cuts can exceed 1% of GDP, says one estimate. Add fertiliser support to that, and the burden rises further and the deficit goes haywire. In response, the government will cut capital expenditure (capex) which is India’s main growth engine in recent years.
If the war continues, we will see a vicious cycle emerge. Energy drives fertiliser costs, fertiliser drives food prices, food drives inflation and inflation feeds back into energy through currency depreciation. Rising costs from dearer fuel and fertiliser will leave households with less discretionary spending and tax revenues will soften. The system can absorb shocks in the first few weeks. Beyond that, the problem will appear through many small changes: a few percentage points off margins, a few weeks of delayed production, a few basis points added to inflation. Each time, the market will react. And because these changes will unfold slowly, they are easy to underestimate. Brace yourself for a bumpy ride.
(This article first appeared in Business Standard newspaper)
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I think the story is partially true. First of all, how much is the weight-age of these sector in the economy e.g. aviation. and so on and so forth. Further, are they the only supplier?! Probably no, they are major suppliers in the sectors discussed, if their prices are higher than naturally the competitors will increase the supply. There will be logistic chaos but it is good as the entrepreneurs will find the new way of procurement. Further Indian Government is in good shape and is able to spend for keeping the prices of basic needs in control.
Having said that, no war if it continues for longer periods have ripple effects on the entire globe.
To summarize, not to be afraid but be cautious!!
Similar story was written about Ukraine with respect to fertilizers. Markets shrugged it off over time. Eventually, the supply/demand got sorted out. And the war is still going on there. And Putin is sipping champagne and enjoying the show.
The larger point is that supply chains are extremely robust (when compared to the past) and diversified with fewer points of failures. Of course, there are going to be some bottlenecks, but this will also get sorted out over time.
Is Hormuz a "single point of failure"? Unlikely. Everyone interests depend on it, so saner minds tend to prevail over the medium to long term.
In meantime, traders rejoice. Volatility and chaos is a great way to generate wealth and spot mispricings.
Not only recency bias but a doomsayer mindset also. World would eventually shrug off all these happening and would march forward. Already there are signs of reconciliation between US-Israel and Iran. So no over panic but of course we all need to be cautious and prepare for the future.
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Having said that, no war if it continues for longer periods have ripple effects on the entire globe.
To summarize, not to be afraid but be cautious!!
Similar story was written about Ukraine with respect to fertilizers. Markets shrugged it off over time. Eventually, the supply/demand got sorted out. And the war is still going on there. And Putin is sipping champagne and enjoying the show.
The larger point is that supply chains are extremely robust (when compared to the past) and diversified with fewer points of failures. Of course, there are going to be some bottlenecks, but this will also get sorted out over time.
Is Hormuz a "single point of failure"? Unlikely. Everyone interests depend on it, so saner minds tend to prevail over the medium to long term.
In meantime, traders rejoice. Volatility and chaos is a great way to generate wealth and spot mispricings.