Raghuram Rajan Warns India: Build Oil Reserves and Diversify Trade

Former RBI Governor Raghuram Rajan has issued a critical warning regarding India's economic resilience in the face of rising geopolitical tensions. Highlighting the vulnerabilities exposed by disruptions in the Strait of Hormuz, Rajan argues that India must urgently bolster its strategic reserves and diversify its trade dependencies to avoid future shocks.

Strengthening Energy Security and Strategic Reserves

The recent instability in the Strait of Hormuz has highlighted a significant structural weakness in India’s energy security. As the strait serves as a vital artery for a massive portion of India's crude oil, LNG, and LPG imports, Rajan emphasizes that even a potential peace deal between the US and Iran cannot erase the underlying vulnerability.

To mitigate this, Rajan suggests two immediate paths:

However, he cautioned that the green transition carries its own risks. India currently relies heavily on imported solar cells and wind components, noting that Indian industry must take a more proactive role in building domestic manufacturing capabilities to avoid swapping one import dependency for another.

On the trade front, Rajan noted that while India is in a better position than earlier this year, new challenges are emerging. India faces a 12.5% tariff linked to forced-labor concerns, which is slightly higher than the ~10% rates faced by Bangladesh and Pakistan. A more significant threat, however, is a potential "excess capacity" probe that could lead to additional tariffs.

To counter these risks, Rajan's primary recommendation is rapid diversification. India must reduce its reliance on single import sources and expand its reach into new export markets to ensure that a policy shift in one major economy does not paralyze Indian trade.

Addressing FDI Gaps and the Rupee's Depreciation

Rajan also addressed the structural issues affecting the Indian Rupee, which has depreciated nearly 14% against the US Dollar over the last two years. Interestingly, he attributes this slide not just to oil prices, but to a lack of Foreign Direct Investment (FDI).

While remittance inflows remain strong, Rajan pointed out a disconnect between India's high GDP growth and its domestic investment levels. He described this as a gap between "the walk and the talk," urging policymakers to investigate why domestic investment has not matched the country's headline economic performance. He further suggested that if oil prices stabilize around $85 a barrel, the current account position remains "relatively mild," implying that some recent policy responses to capital inflows may be overreactions.

Looking Beyond Oil: The Next Vulnerability

Finally, Rajan urged a forward-looking approach to commodity management. He warned that the next major shock might not be energy, but pharmaceutical inputs used in generic drug manufacturing. He called for building strategic buffers and strengthening ties with friendly supplier nations to ensure India is not caught off guard by the next supply chain crisis.

Key Takeaways