West Asia Conflict May Pose Short-Term Challenges, with Long-Term Resilience Intact: Julius Baer Analyst

India's Economy at Risk: Understanding the Impact of the Iran Conflict

The recent ceasefire announcements in Iran have left many wondering about the implications for the Indian economy and markets. To grasp the full extent of the impact, it's essential to understand the three primary channels through which this conflict affects India.

Trade Shock and Inflation

The most significant channel is the terms of trade shock, resulting from the steep rise in crude prices. This inflationary pressure inflates India's import bill, exacerbating the trade and current account deficit, and leading to higher input prices for industry and consumers. The subsequent higher inflation rate weakens discretionary consumption, ultimately negatively impacting economic growth. The current account is also affected by reduced export demand from the Gulf region and lower remittances from the large Indian population in these countries.

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Comparison of Economic Impacts

Investor Sentiment and Capital Account

Global investors are concerned about countries that are significant energy importers, leading to Foreign Portfolio Investors (FPIs) selling in the Indian markets. FPI selling worsens India's capital account situation and puts pressure on the Rupee. A falling Rupee can further compound the impact of imported inflation and lead to increased interest rates. The uncertainty also creates a negative rub-off on equity fund raising and can delay corporate investment decisions, ultimately affecting growth.

Read also: US-Iran Tensions Spark Uptick in Oil Prices Amid Global Market Decline

Disruption in Marine Traffic

The disruption in marine traffic has the potential to create shortages of input materials across various sectors, similar to the impact seen during the Covid-19 pandemic. This disruption is growth-negative and can lead to shortages and higher costs for industries.

Short-Term vs. Long-Term Impact

While the conflict creates short-term headwinds for India's markets and economy, leading to higher inflation and lower growth in the near term, it's essential not to get too pessimistic. These shocks are not permanent headwinds for the economy and will work their way through the system over time. The length of the war will define the extent of the pain in the current year and does not change India's longer-term trajectory.

Markets' Reaction and Uncertainty

The markets reacted euphorically to last week's ceasefire announcement, but significant uncertainty remains about the future course of the conflict and when and how the ceasefire can become permanent. The uncertainty surrounding the oil infrastructure's ability to come back on stream following a ceasefire also contributes to market volatility.

Corporate Earnings and Impact

Given that the disruptions only impacted the last few days of the quarter, we do not expect Q4FY26 numbers to significantly show the effect of the war. However, markets will be keenly listening to management commentaries during the ongoing quarterly result window to understand the impact on the ground. If the disruptions persist and take many more weeks or months to resolve, they would definitely bring in earning cuts for FY27 earnings.

FPI Selling and Market Volatility

FPIs have been selling in markets that are big energy importers, resulting in a sharp selling by Foreigners. In fact, they have sold almost the same amount that they sold over the entire CY25 (USD18.9 billion), in just the first 3.5 months of CY26 (USD18.9 billion YTD). However, we think the worst of the selling may be behind us, as the Nifty is trading close to its long-term average and the lowest that it's been in the last couple of years.

Long-Term Equity Returns and Nominal GDP Growth

Since FY93, BSE Sensex has delivered a 12 percent EPS CAGR, similar to the nominal GDP growth over this period. Going forward, we expect our long-term equity returns to track nominal GDP growth. While the conflict can affect us over the short to medium term, there is no reason to worry about our long-term trajectory. Volatility has been an integral feature of the market, but so has been growth.