India’s Fiscal Shield Comes Into Focus As Hormuz Crisis Darkens Outlook

By K Raveendran

Resolution of the US-Israel war with Iran now appears further away than at any point in the conflict, with the latest American strikes pushing global markets into a more unsettled phase. The US launch of retaliatory attacks on Iranian defence and radar systems after Washington accused Tehran of responsibility for the downing of an American Apache helicopter near the Strait of Hormuz has shifted attention from the risk of a contained military exchange to the possibility of a prolonged confrontation in one of the world’s most important energy corridors.

For investors, the significance of the escalation lies not only in the exchange of fire, but in the location and timing. The Strait of Hormuz is central to global oil and liquefied natural gas flows. Any sign that military operations are becoming normalised near the waterway immediately feeds into crude prices, shipping insurance, freight rates and inflation expectations. Even without a full closure of the strait, the mere prospect of repeated incidents can add a substantial risk premium to every barrel moving out of the Gulf.

The immediate danger is not necessarily a single dramatic escalation. A spectacular confrontation would be severe, but it might also force urgent diplomacy. The more difficult risk for markets is that the conflict becomes entrenched through intermittent strikes, retaliatory operations, drone incidents, cyberattacks, warnings to vessels and proxy activity across the region. That pattern would be harder to price because it would keep supply fears alive without producing a single decisive moment of crisis.

Washington may describe its strikes as limited and retaliatory, but the military threshold has moved. Tehran is unlikely to treat attacks on its defence infrastructure as an episode that can be absorbed without response. Israel, already deeply engaged in the confrontation with Iran, may view any Iranian move as further justification for military action. Each side can say it is responding rather than escalating, yet the cumulative effect can still be a wider and more durable conflict.

That prospect matters because markets had grown used to absorbing geopolitical shocks as long as energy supplies remained broadly intact. The present confrontation is different because it directly links military risk to inflation. Oil price spikes are not just a commodity-market issue. They raise transport costs, fertiliser costs, utility bills and food prices. They also complicate the work of central banks that are trying to ease policy without allowing inflation expectations to revive.

For the Modi government, the conflict poses a particularly sharp policy test. India is heavily dependent on imported crude, gas and fertiliser inputs, much of which is exposed to Gulf shipping routes. A prolonged confrontation near Hormuz would not merely raise the import bill; it would force New Delhi to decide how much of the shock should be absorbed by the state and how much should be passed on to consumers. That decision has economic, fiscal and political consequences.

The government is already expected to look at several measures to raise or conserve resources for emergencies linked to the Gulf conflict. These could include tighter control over non-essential expenditure, reworking subsidy allocations, tapping dividend flows from public-sector companies, accelerating disinvestment receipts where feasible and using higher duties or levies selectively if oil prices remain elevated. Such measures would not be cost-free. Any attempt to raise revenue during an inflationary energy shock risks hurting consumption, while unchecked subsidies would widen the fiscal burden.

Fuel pricing is the most sensitive area. Passing the full burden of higher crude prices to consumers would feed quickly into inflation and household budgets. Absorbing the shock through state-owned oil marketing companies would weaken their balance sheets and may eventually require budgetary support. Cutting excise duties would soften pump prices but reduce government revenue just when emergency spending needs are rising. This is the central dilemma for New Delhi: the same crisis that demands fiscal support also narrows the room to finance it.

Fertiliser is another pressure point. India’s farm economy depends heavily on affordable fertiliser, and the government has historically used subsidies to cushion farmers from global price swings. A Gulf conflict that raises gas and fertiliser import costs would increase subsidy demands at the same time as food inflation risks rise. With weather uncertainty also a recurring concern, the government would have little room to allow a sharp increase in farm input costs before a politically sensitive agricultural season.

The rupee adds another layer of vulnerability. Higher crude prices typically increase dollar demand from importers and widen the current account deficit. If investors also move towards safe-haven assets, emerging-market currencies can come under further pressure. A weaker rupee then makes oil, gas and fertiliser imports even more expensive, creating a feedback loop between external vulnerability and domestic inflation. The Reserve Bank of India may be forced to balance currency support with the need to preserve reserves and avoid excessive tightening.

India’s policymakers therefore face a three-way squeeze: protect consumers, preserve fiscal credibility and maintain growth. The economy has domestic demand strength, but high energy prices can erode disposable income, raise corporate costs and delay private investment. Airlines, logistics firms, chemicals, cement, steel and transport-linked sectors would be among the first to feel the strain. Small businesses would face higher working-capital needs, while households would see the impact through fuel, cooking gas, food and transport costs.

The political stakes are also significant. The Modi government has built much of its economic messaging around infrastructure spending, welfare delivery and macroeconomic stability. A Gulf crisis threatens all three. Capital expenditure may be difficult to cut because it supports growth and employment, but revenue spending on subsidies and emergency buffers could rise sharply. Welfare commitments cannot easily be diluted when inflation is hurting lower-income households. Fiscal consolidation targets may therefore come under pressure if the confrontation persists.

The Gulf states face their own paradox. Higher oil prices may improve revenue for producers, but a militarised Hormuz threatens the stability on which their broader economic models depend. The UAE, Saudi Arabia, Qatar, Kuwait and Bahrain have invested heavily in logistics, finance, tourism and non-oil growth. A drawn-out confrontation would raise security costs, unsettle investors and expose the region’s dependence on safe maritime routes.

The turning point for markets may therefore be psychological. Energy prices, inflation expectations and fiscal planning are again being shaped by war risk. For India, the crisis is no longer a distant geopolitical event but a direct test of economic management. The confrontation may still be contained, but containment has become harder to assume. That uncertainty is now the central market fact. (IPA Service)