Raghuram Rajan Warns India: Build Oil Reserves and Diversify Trade

Economist 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 the nation's energy and trade security. He argues that while headline trade volumes remain stable, the cumulative impact of disrupted trade routes and shifting tariff landscapes requires a fundamental rethink of India’s economic resilience.

Strengthening Energy Security and Strategic Reserves

Rajan noted that the potential for disruption in the Strait of Hormuz remains a significant threat, given the strait's massive role in India's imports of crude oil, LNG, and LPG. He argued that a potential US-Iran peace deal is not a permanent fix for the underlying vulnerability. To mitigate this, Rajan suggests that India must significantly expand its strategic oil reserves.

Beyond oil, Rajan advocated for flexible backup energy options. He pointed to China’s model of ramping up coal production during supply shocks as a pragmatic short-term strategy, while simultaneously pushing for a long-term transition to renewables. However, he cautioned that the green transition introduces new risks; India currently relies heavily on imported solar cells and wind components, necessitating a stronger domestic manufacturing push to avoid replacing oil dependency with a renewable supply-chain dependency.

On the trade front, Rajan highlighted the complexities of navigating US tariff policies. He specifically flagged an incoming 12.5% tariff tied to forced-labor concerns, noting it is slightly higher than the ~10% rates faced by Pakistan and Bangladesh. A more significant threat, however, is a potential "excess capacity" probe that could stack additional tariffs on top of existing ones.

To protect against such shocks, Rajan’s primary recommendation is diversification. India must reduce its exposure to single-source imports and single-destination exports to ensure that geopolitical friction in one region does not paralyze its entire economic engine.

Addressing the Rupee and the FDI Gap

Addressing the rupee's sharp depreciation—which has fallen nearly 14% against the US dollar over the last two years—Rajan identified a structural rather than purely commodity-driven issue. While oil prices are a factor, he pointed to a critical gap in Foreign Direct Investment (FDI). Despite strong headline GDP growth and steady remittance inflows, domestic investment has not matched the country's growth narrative. He described this discrepancy as a gap between "the walk and the talk" that policymakers must urgently address to stabilize the currency and fuel long-term growth.

Looking Beyond Oil: The Next Vulnerability

Rajan warned that India's strategic planning must look 3-to-5 years ahead. He cautioned that the next major vulnerability might not be energy, but rather the supply of pharmaceutical inputs essential for India's massive generic drug industry. He urged the government to build strategic buffers and domestic production capacities for all critical commodities, treating recent geopolitical shocks as a vital "wake-up call."

Key Takeaways