US-Iran Conflict and Its Economic Implications
The ongoing US-Iran conflict is significantly influencing global energy markets, with crude prices increasing by over 50% and gas prices by more than 70% since February. This surge poses a substantial supply shock to energy importers, reminiscent of the challenges faced during the Covid pandemic, where both growth and inflation were adversely affected.
Nature of the Current Supply Shock
This supply shock differs from the 2022 Russia-Ukraine conflict, impacting not just prices but also the availability of crude, gas, and LPG, especially critical for India, which relies heavily on imports from the Strait of Hormuz. The prolonged closure of this strait could exacerbate economic activities across various sectors.
- Quantitative Constraints:
- Economic activities may be curtailed significantly if essential energy resources remain scarce.
- Non-linearities may emerge, making economic recovery challenging once activities shut down.
Policy Response in Three Phases
Phase 1: Keeping the Lights On
- Augment Domestic Production: Increase local production to mitigate shortages, particularly of LPG.
- Global Scouting: Seek energy resources globally, even if it means purchasing at higher prices.
- Rationing: Efficiently allocate available resources between households and commercial sectors to prevent economic disruptions.
- Subsidies and Incentives: Encourage the production of alternatives like induction stoves to reduce reliance on scarce resources.
Phase 2: Activating Internal and External Shock Absorbers
- Price Impact Management: Internal distribution of the crude price shock between the public and private sectors.
- Retail Price Adjustment: Gradual increase in retail fuel prices to reflect global prices and manage consumption.
- Rupee Depreciation: Allowing the rupee to depreciate to balance the terms-of-trade shock, aiding exports and constraining imports.
Phase 3: Strategic Reset
- Learning from Past Crises: Emulating post-2013 measures, like building FX reserves and robust economic frameworks.
- Risk Management: Identifying chokepoints in key sectors and building strategic reserves similar to China, Korea, and Japan.
- Diversification: Shifting focus from fossil fuels to renewables, energy storage, and electrification to reduce dependency and manage price risks.
The strategic reset aims to not only boost growth rates but also reduce growth volatility by preparing for future shocks. Though this entails costs, the stability it offers justifies these investments. The current priority, however, is managing the immediate crisis with minimal disruption.
