Raghuram Rajan Urges India to Build Oil Reserves and Diversify Trade

Former RBI Governor Raghuram Rajan has issued a critical warning to Indian policymakers, emphasizing that geopolitical tensions in the Strait of Hormuz have exposed deep-seated vulnerabilities in India’s energy and trade security. As global trade routes face increasing disruption, Rajan argues that India must shift its focus toward long-term economic resilience rather than just managing immediate headlines.

Strengthening Energy Security and Strategic Reserves

Rajan highlighted that the Strait of Hormuz remains a critical choke point, accounting for a massive share of India's crude oil, LNG, and LPG imports. He argued that a potential peace deal between the US and Iran is not enough to ensure stability; instead, India must proactively build much larger strategic oil reserves.

Beyond oil, Rajan suggested that India needs flexible backup energy options. He pointed to China's model of being able to rapidly ramp up coal production during crises as a viable short-term strategy. While he advocates for a long-term transition to renewables, he warned that the green energy transition carries its own risks. Currently, India remains heavily dependent on imported solar cells and wind components, and he called for Indian industry to take a more aggressive role in manufacturing these domestic alternatives.

Mitigating Trade Risks and Tariff Threats

On the trade front, Rajan noted that while India is currently navigating US tariff threats better than earlier this year, new challenges are looming. He flagged a specific 12.5% tariff tied to forced-labor concerns—slightly higher than the ~10% rates faced by Bangladesh and Pakistan. However, he identified a more significant risk: an upcoming "excess capacity" probe that could stack additional tariffs on top of existing rates.

To counter these threats, Rajan’s primary recommendation is diversification. India must reduce its exposure to any single shock by diversifying both its import sources and its export markets, ensuring that geopolitical shifts in one region do not paralyze the national economy.

Addressing the Rupee and Investment Gaps

Rajan also addressed the structural reasons behind the rupee's 14% depreciation against the US dollar over the last two years. He argued that the slide is not merely a result of fluctuating oil prices but a sign of insufficient Foreign Direct Investment (FDI). While remittance inflows remain strong, he noted a troubling gap between India's high headline GDP growth and its actual domestic investment levels.

He cautioned policymakers against overreacting to current account positions with costly incentives, such as the FCNR(B) proposal, especially if oil prices stabilize around $85 a barrel. Instead, he urged a focus on attracting high-quality capital that can sustain long-term growth.

Looking Beyond Oil: The Next Vulnerability

Finally, Rajan warned that the next economic shock might not come from energy, but from critical pharmaceutical inputs used in generic drug manufacturing. He urged the government to adopt a three-to-five-year outlook for all critical commodities, building strategic buffers and domestic production capacities to ensure India is never caught off guard again.

Key Takeaways