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A closed Strait of Hormuz (SoH) blocks 7% of global energy supply. If sustained for a year, despite offsets from substitution and efficiency, global growth impact could be 4-5%. Supply shortages (disrupted value chains) and reflexivity from volatile financial markets are also factors. $100/bbl crude (and gas) for a year is likely to worsen terms of trade by US$80bn (2.1% of GDP): higher fiscal deficit may reduce some growth impact. A US$60bn BoP deterioration may need both a weaker INR and higher rates. While we don’t expect the disruption to last beyond a few weeks, as Iran is relying on market volatility as its bargaining chip, higher volatility may be necessary to reopen the SoH.
7% of global energy supply disrupted; India impacted by price moves
The closing of the Strait of Hormuz (SoH) blocks 7% of global energy supply. If this supply remains inaccessible for a full year, even building in substitution and efficiency gains, we estimate it can drag down global growth by 4-5%. The impact on energy/supply chains of the period of disruption is likely to be non-linear. Higher prices would push out weaker economies/consumers; economies with net energy imports at high share of GDP would also be hurt, e.g., North Asia. While ~10% of India’s energy flows are directly affected by SoH closure (a third of gas supply), substitution (e.g. gas to coal for power) and diversion (ability to buy at higher prices) mean the impact would be via higher prices.
With oil at $100, annualized terms of trade shock for India could be 2% of GDP
If oil stays above $100/barrel for a year, in addition to the global growth shock and financial market disruption, we estimate the direct terms of trade shock to be $80bn (2.1% of est. FY26GDP): 80% energy and 20% fertilizers, edible oil, etc. We expect this shock to be managed via growth and fiscal channels, with some non-linearity in fiscal intervention. Some buffer can also come from OMCs which benefited from subdued oil prices since 2023. The BoP impact could be $60bn (higher CAD, FPI outflows offset by lower FDI repatriation and unchanged ECBs), necessitating a weaker INR.
We do not expect the war to last long; if it does, rates may have to go up
We believe much higher market volatility may be an important part of getting the warring parties to agree to a reopening of the SoH, especially as it would be a tool for Iran to get better terms. This may show up in the next few weeks (oil markets expect so too). If oil prices do not fall, given the scale of the BoP adjustment, it would be unwise to let all the adjustment occur through the INR NEER. Rate hikes may be necessary to slow the economy. There are upside risks to inflation too, based on RBI’s model. The economy may need to run with a significant labour market slack till energy prices stay high.
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