Iran–US tensions add fresh macro and market risks for India

The sudden and sharp escalation in the conflict between Iran and the United States over the weekend is likely to trigger a risk-off sentiment in global markets until the situation stabilises. With the duration, magnitude and eventual outcome of the conflict highly uncertain, the development may exert additional pressure on India’s macroeconomic environment through higher crude oil and natural gas prices.

The Indian market is already grappling with elevated valuations and the potential impact of artificial intelligence on the information technology services sector, which constitutes a significant portion of both the Indian economy and equity markets.

Higher oil prices, in particular, pose a significant challenge. Rising crude prices are negative for India’s balance of payments, current account deficit (CAD) and, more importantly, the rupee.

The sharp increase in crude oil and related energy prices in recent days could widen India’s CAD if the elevated price levels persist for long. According to estimates by Kotak Mahindra Bank, India’s CAD-to-GDP ratio for the year is projected at around 1 per cent, based on a dated Brent crude price assumption of $65 per barrel.

A $10 per barrel increase in crude oil prices, along with a similar rise in gas prices compared with analysts’ base-case estimates, could add roughly $22 billion to India’s CAD, translating into an additional 0.55 per cent of GDP. High gold prices and rising imports due to risk-off sentiment may further weaken the CAD, while subdued foreign portfolio investor (FPI) flows could weigh on the overall balance of payments.

Given the prevailing high valuations, the market band is likely to shift lower, resulting in a range-bound market environment. India’s macroeconomic vulnerability to higher crude oil prices is greater than that of many other emerging markets. Unlike several emerging economies that run large current account surpluses, India typically runs a higher CAD. This structural vulnerability, combined with high market valuations, could keep investor sentiment subdued.

Weak sentiment may lead to continued muted performance in Indian equities. FPI flows are likely to remain soft, while domestic retail sentiment may also weaken if returns remain subdued for an extended period, particularly if tensions in the Middle East persist or escalate further. However, the earnings impact across sectors may be nuanced and relatively limited if the duration of the conflict remains short.

Experts believe that higher oil and gas prices could have a mixed impact on corporate earnings. A sustained period of high oil prices may be positive for the net profits of the Nifty-50 Index through higher profits of ONGC, going by the sensitivity of ONGC to crude oil and gas prices. At the same time, the government could impose a windfall tax if crude prices rise above certain thresholds, as it has done in the past.

Higher oil prices would be negative for several sectors across the broader market. Aviation companies and oil marketing companies (OMCs) are likely to be the most affected due to limited pricing power. Commodity chemicals and construction materials sectors may also see a moderate negative impact on profitability. Sectoral studies of the Nifty 50 Index indicate that the net profit impact would vary widely across industries and companies.