Raghuram Rajan Warns India: Build Oil Reserves and Diversify Trade

Former RBI Governor Raghuram Rajan has issued a critical wake-up call to Indian policymakers, emphasizing that geopolitical tensions like the Strait of Hormuz crisis must drive a fundamental shift in economic resilience. He argues that while immediate data may not show a collapse in trade, the underlying vulnerabilities in energy and supply chains require urgent structural changes.

Strengthening Energy Security and Strategic Reserves

Rajan highlighted that the disruption in the Strait of Hormuz exposes a significant vulnerability for India, given its heavy reliance on the region for crude oil, LNG, and LPG imports. He argued that even a potential US-Iran peace deal would not eliminate the inherent risks posed by these volatile trade routes. To mitigate this, Rajan strongly recommended that India build much larger strategic oil reserves than it currently maintains.

Beyond oil, he suggested that India requires flexible backup energy options. While promoting a long-term transition to renewables, Rajan noted that India must adopt a pragmatic approach, similar to China’s ability to ramp up coal production during shortages. However, he cautioned that the green transition itself carries risks; India remains heavily dependent on imported solar cells and wind components, urging domestic industry to take a more proactive role in manufacturing these critical technologies.

On the trade front, Rajan noted that while India is currently managing US tariff threats better than earlier this year, new challenges loom. He flagged an upcoming 12.5% tariff linked to forced-labor concerns—slightly higher than the 10% rates faced by Bangladesh and Pakistan—and warned of a potential "excess capacity" probe that could lead to even higher duties.

To protect against such geopolitical maneuvering, Rajan’s primary advice is diversification. He urged India to reduce its exposure to any single shock by diversifying both its import sources and its export markets, ensuring the economy is not overly reliant on specific trading partners or volatile corridors.

Addressing Structural Gaps in Investment and the Rupee

Addressing the rupee's depreciation—which has fallen nearly 14% against the US dollar over the last two years—Rajan pointed to a structural disconnect. He argued that the slide is not merely a result of oil prices but a symptom of India’s inability to attract sufficient Foreign Direct Investment (FDI). Despite strong headline GDP growth and consistent remittance inflows, he noted a significant gap between "the walk and the talk" regarding domestic investment levels.

He also offered a tempered view on the current account, suggesting that if oil prices stabilize around $85 per barrel, the situation remains "relatively mild." In this context, he cautioned policymakers against overreacting with costly capital-inflow incentives like the FCNR(B) proposal.

Looking Beyond Oil: The Next Vulnerability

Rajan concluded by advising a three-to-five-year strategic view on commodity exposure. He warned that the next major shock might not be energy-related but could involve pharmaceutical inputs essential for India's massive generic drug industry. He called for building strategic buffers and stronger ties with friendly supply nations to ensure long-term stability.

Key Takeaways