Raghuram Rajan Warns India: Build Oil Reserves and Diversify Trade

Former RBI Governor Raghuram Rajan has issued a critical warning to Indian policymakers, stating that geopolitical tensions and disrupted trade routes are reshaping global economic resilience. He emphasizes that India must urgently address vulnerabilities in energy security and trade dependencies to avoid future economic shocks.

Strengthening Energy Security and Strategic Reserves

Following the disruptions in the Strait of Hormuz, Rajan argued that India remains dangerously exposed due to its heavy reliance on the strait for crude oil, LNG, and LPG imports. He noted that even a potential US-Iran peace deal would not erase the underlying structural vulnerabilities exposed by the crisis.

To mitigate this, Rajan proposed two primary solutions. First, India must significantly expand its strategic oil reserves. Second, the country needs flexible backup energy options. He suggested that India should develop the capability to ramp up coal production—similar to China's model—as a short-term buffer while transitioning to renewables. However, he cautioned that the renewable transition itself carries supply-chain risks, as India remains dependent on imported solar cells and wind components, necessitating a stronger domestic manufacturing push.

On the trade front, Rajan highlighted that while India is currently in a better position than earlier this year, new risks are emerging. He flagged an incoming 12.5% tariff linked to forced-labor concerns, which is slightly higher than the 10% rates faced by neighbors like Pakistan and Bangladesh.

A more significant concern, according to Rajan, is the potential for an "excess capacity" probe, which could lead to additional layers of tariffs. To insulate itself from such geopolitical volatility, he urged Indian industry and policymakers to diversify both their import sources and their export markets, ensuring the economy is not overly reliant on any single trading partner or route.

Addressing the Rupee and Investment Gaps

Rajan also touched upon the structural issues affecting the Indian Rupee, which has depreciated nearly 14% against the US Dollar over the last two years. He argued that this slide is not merely a function of fluctuating oil prices but a symptom of a deeper issue: India is failing to attract sufficient Foreign Direct Investment (FDI).

While remittance inflows remain robust, Rajan pointed out a disconnect between India's high headline GDP growth and its relatively low domestic investment. He cautioned policymakers against overreacting to current account positions with costly capital-inflow incentives, such as the FCNR(B) proposal, suggesting instead a focus on closing the gap between economic potential and actual domestic investment.

Looking Beyond Oil: The Next Vulnerability

Looking ahead, Rajan warned that the next major shock might not be energy-related but could involve pharmaceutical inputs required for generic drug manufacturing. He called for a three-to-five-year strategic view to build buffers in critical commodities, expand domestic production capacity, and strengthen ties with friendly supply nations.

Key Takeaways