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MUMBAI: For India, the fallout from West Asia conflict, while negative for the macro-economy, would remain manageable if a final peace deal is reached by mid-May.
Any extension beyond that could push up oil price expectations and have a more severe impact, not just on the macro, but also on earnings for the current fiscal, which are otherwise expected to hold up better than the economy in the context of the war, according to Sanjeev Prasad, managing director and co-head, Kotak Institutional Equities.
In an interview to Mint, he also explained why foreign investors continue to pull out despite valuations correcting.
It is a little bit of a challenge as of now. The hope was that the West Asia war would end by early April...then mid-April and at the end of last month we were hoping for mid-May. It just keeps on dragging. Obviously, it has negative implications for India's macro and also micro to some extent; more for macro I would say.
In early March, we were working with a crude oil price assumption of $85 per barrel for the full year, which means effectively high prices in the first few months and then lower prices. Now, two months are already over, and there are no signs of any peace framework.
The assumption in the first two months was that since a lot of the developed countries were sitting on large amounts of inventory, they could deplete the inventory for the first few months and still manage.
But now with the war continuing for longer, there are more challenges. First, oil supply is lower than expectations, which could be in the range of around 10 million barrels per day, or nearly 10% of the 104 million barrels per day consumed globally. And that will sustain as long Hormuz is choked.
Second, as inventory levels in the rest of the world, particularly in the OECD (Organisation of Economic Cooperation & Development) countries, start to come down, they will start to buy more aggressively, which could further push up prices.
So far, the world has managed by reducing inventory. But then, what happens once inventories plummet? The challenge is, depending on the duration of the war, the magnitude of oil prices will vary a lot… oil price expectations will keep on moving up.
If you look at the implications for the macro, assuming the war gets over by mid-May, it is still not a great scenario for India compared to the pre-war scenario. Because one will still be looking at maybe $85 per barrel crude price on average for FY27, which implies a current account deficit (CAD) of 2% of GDP, that is, twice as much of the pre-war level. Also, the balance of payments (BoP) will be under pressure because capital flows – both portfolio (FPI) and strategic (FDI) – could continue to be weak. So, the BoP could be a negative $50 billion, which is still manageable for a year because India has $700 billion of foreign reserves.
A large negative BoP will put pressure on the currency at the same time. Also, high oil prices have implications for the fiscal deficit and inflation, depending on how the government wants to look at retail fuel prices.
If the government were to allow the oil companies to raise retail prices, inflation will be higher, as petrol has a significant weight of 4.5% in the CPI basket. And one will also have inflation feeding in through various other routes. Manufacturing costs will increase because industrial fuels – gas and coal – prices have gone up.
Either energy costs have gone up for every manufacturing entity or raw material prices have gone up because of higher prices of oil derivatives, which are used in many industries – packaging, plastics, pharmaceuticals among others. So, manufacturing inflation will go up. If the government were to raise diesel prices, transportation costs would increase.
In this scenario, the RBI will hold interest rates at best. At crude price of $85/bbl, India can still manage, as inflation could be closer to 5%.
But if one was to look at an adverse scenario of average crude price being, say, $100 dollars per barrel for FY2027, one is looking at 2.5% plus kind of a CAD and BoP could be a negative $80-90 billion, depending on what capital flows one assumes. Central fiscal deficit could rise to around 4.5-5% because the government may have to absorb some of the increase in price of crude oil, as I do not think it will pass on the full increase. Inflation could go to more like 5.25 to 5.5% in this scenario. RBI may have to tighten and raise rates. That is not a good scenario because then growth will also be impacted negatively.
Yes, even though the macro could deteriorate depending on how long the war lasts, earnings numbers paradoxically may not get impacted that much.
And the reason for that is about 50% of the profits of the Nifty 50 index come from either sectors which have low linkage to the domestic economy or are insulated from its vagaries.
[Of this] roughly, 25% comes from global commodity sectors like metals & mining and oil, gas & consumable fuels, another 13% comes from global services sector, which is IT services, and another 2% from pharmaceuticals , which is also largely global in nature. So, 40% of the net profits of the Nifty-50 Index actually come from sectors which are global in nature. So they should be fine assuming there is no major global demand destruction.
And, in fact, one could see earnings upgrade because metal prices are higher than what we have assumed. Oil prices could also be higher than what we assumed.
Another 10% comes from sectors which are somewhat insulated from the changes in the domestic economy. Because they are more utility type sectors -- NTPC, power grid, telecom etc. whose earnings numbers may not get impacted that much.
Of the rest , another one-third comes from banks and NBFCs. Now here it is a bit tricky. In the base-case scenario, they should be okay, as extension of the conflict through May would not damage credit growth or credit cost too much. But if the war to continue for longer, then both credit growth and credit cost will be impacted negatively.
Banks and NBFCs will start tightening in terms of lending on concerns of potential non-performing loans. They will definitely tighten their internal credit filters etc. in the event of a prolonged crisis. Thus, credit growth will be lower and if this situation was to continue for long then, credit costs may also go up.
So far, things looks okay. If you look at the numbers of the banks for the March quarter they have reported a very good set of earnings. The same is true for NBFCs also. In fact, their earnings outlook is better than in FY2026 with higher credit growth and lower credit costs. NIMs (net interest margins) should logically be flat going forward given whatever rate cut had to happen has already happened.
The balance 17% , or one-sixth, comes from sectors which have a very direct linkage to the economy -- autos, consumer goods , cement, paints , etc , which are domestic consumption plays. So , here there will be some earnings implication because margins will be squeezed.
If oil were to average $100 or more for the fiscal, the earnings growth estimate of 19% will take a hit but it's difficult to put a finger on the extent of decline.
The impact on earnings will depend on the duration of the war and the duration of the war depends on the economic will and the political will of the two parties—Iran and the US.
What is the economic will of the US to continue this for long? I assume it should not be very strong because there is going to be pain in the US also -- higher gasoline prices, transportation prices, higher inflation and, who knows, maybe higher interest rates also. Having said that, the US is a large, rich economy and can manage the economic challenges.
The more important point is whether the political will is there to continue [the war] for long. External policy or foreign policy is generally very low in the pecking order of a US citizen. For the common man in the US, do gasoline prices matter or Iran having a nuclear program? Gasoline prices is on top of the mind. Also, the current administration had said that the US will not get into endless wars, have an America -first policy etc. Suddenly, it seems to have reversed all that. Based on various polls and surveys, it appears that the political support for an extended war is very low.
Let's not forget the mid-term polls in the US, which could queer the pitch for the Republicans.
But what is the deal per the US? The Strait of Hormuz has to be reopened and Iran should not have a nuclear weapon. Whether "should not have" is forever or for a certain number of years is ultimately what matters, I would assume. If it is for a certain number of years, there could be a deal. If it is forever, I don't think we have a deal.
Now coming to Iran. The economic will [to end the war] is there because the US blockade in the region would squeeze its funding lifeline. The political will, too, I would assume, but that requires two things. One is some sort of a guarantee that the US will not restart an attack after a few months. So, it would a more fool-proof security guarantee. Secondly, some postponement of nuclear enrichment alongside handing over the 440 kilos of enriched uranium for monitoring by a neutral third party acceptable to both sides could result in a deal.
The problem is a lot of the earnings in the Indian market is incrementally coming from all the commodity sectors -- metals & mining, oil, gas & consumable fuels-- and banks, which , to my mind, are relatively low PE plays.
Secondly, several other markets - South Korea, Taiwan, Brazil -- are expected to see very strong earnings growth, thanks to the two big themes playing out globally -- AI and commodities. From India’s perspective, if anything, AI is a threat for our IT services firms and India is a actually a large consumer or importer of commodities, rather than a producer. There are very few Indian companies to play these themes.
When we talk about emerging markets, investors are looking at a combination of China, South Korea and Taiwan. But, more Korea and Taiwan, because these two are hardcore AI plays. And Brazil is a commodities play. Their valuations of these markets on a one-year forward basis are way lower than India’s and their earnings growth is extremely high.
Whether the earnings growth will sustain or not after two years, one doesn't know because it's all coming from high demand for chips and commodities. Take Korea's Kospi, for example, whose earnings are expected to grow 220% this year and which trades at a PE of 8x one-year forward earnings. And in 2027. it's expected to grow another 25% , thanks to a long chip cycle, which means its semicon companies will deliver very strong earnings for another year.
But the biggest ‘problem’ of all for us is the US. The S&P earnings growth this calendar year or our FY27 is estimated at 22% , trading at 20.5x one-year forward. NASDAQ with an estimated earnings growth of 37% in calendar 2026 is trading at about 26x one-year forward. This is what India is competing with.
Many FPIs who are US-centric or US-based have little incentive to look at markets like ours for investing, especially when they are earning a 4% plus risk free yield in the US bond market.
So, until such time the AI and commodity cycles continue FPI outflows from India might not reverse.
Ram Sahgal is a deputy editor at Mint. He has over 20 years of experience in journalism, with previous roles at The Intelligent Investor, Bombay Times, The Economic Times, and The New Indian Express. Between his media roles, he briefly worked at a commodities exchange before returning to his true passion, business journalism. Ram graduated in liberal arts from St Xavier’s College, Mumbai, where he studied films, which explains his move to Bombay Times, where he covered the film industry during the rise of Sunny Deol and Sanjay Dutt. He took a leap of faith to transfer to The Economic Times, and thanks to his restless mind, later moved to cover the commodities beat. Over the past three years, Ram has been tracking the stock markets at Mint. His focus areas include writing about market infrastructure institutions, brokerages, derivatives, and related regulations. His hobbies include spotting trains and understanding the locomotives that power them. In his free time, he takes his octogenarian mother out for drives and goes to the cinema with her on weekends. If he has a dream, it is to write a screenplay for a movie. For now, he enjoys viewing market data on NSE and BSE, observing the shifting mood of Mr Market, and conversing with market experts.
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