Raghuram Rajan Warns India: Build Oil Reserves and Diversify Trade

Former RBI Governor and economist Raghuram Rajan has issued a critical wake-up call for India, urging the nation to strengthen its economic resilience against geopolitical volatility. Following disruptions in the Strait of Hormuz, Rajan emphasizes that India must move beyond reactive policies and build robust strategic buffers to protect its economy from future energy and trade shocks.

Strengthening Energy Security and Strategic Reserves

Rajan highlighted that the vulnerability exposed by the potential disruption of the Strait of Hormuz cannot be ignored, regardless of any US-Iran peace developments. Since the strait is a vital artery for India’s crude oil, LNG, and LPG imports, Rajan argues that India’s current strategic oil reserves are insufficient.

To mitigate these risks, he suggested a dual-track approach. In the short term, India needs flexible backup options, such as the ability to rapidly ramp up coal production, similar to the model used by China. In the long term, while the shift toward renewables is essential, Rajan warned of a new dependency: the solar and wind supply chains. He noted that India remains heavily reliant on imported solar cells and wind components, calling on domestic industry to take a more aggressive role in manufacturing these technologies locally.

On the trade front, Rajan noted that while India is currently better positioned than earlier this year, significant risks remain. He specifically flagged an incoming 12.5% tariff tied to forced-labor concerns, which is slightly higher than the 10% rates faced by competitors like Pakistan and Bangladesh.

More concerning, however, is the potential for an "excess capacity" probe that could lead to additional tariffs. To safeguard against such protectionist measures, Rajan advised that India must diversify both its import sources and its export markets to ensure that a single geopolitical or regulatory shock does not paralyze its trade ecosystem.

Addressing the Rupee and the Investment Gap

Addressing the rupee's 14% depreciation against the US dollar over the last two years, Rajan pointed toward structural issues rather than just oil price fluctuations. He identified a significant gap between India's strong headline GDP growth and its actual level of domestic and foreign investment.

While remittance inflows remain strong, Rajan argued that India is not attracting enough Foreign Direct Investment (FDI) to match its economic potential. He cautioned policymakers against overreacting to current account positions with costly incentives, such as the FCNR(B) proposal, suggesting instead that the focus should remain on closing the gap between "the walk and the talk" regarding domestic investment.

Looking Beyond Oil: The Next Vulnerability

Rajan concluded by urging a three-to-five-year strategic outlook. He warned that the next major economic shock might not be energy-related but could stem from critical commodity dependencies, such as the pharmaceutical inputs required for India's massive generic drug industry. He called for the immediate building of strategic buffers and stronger ties with "friendly supply countries" to ensure long-term stability.

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