Raghuram Rajan Warns India: Build Strategic Reserves and Diversify Trade

Former RBI Governor Raghuram Rajan has issued a critical warning to Indian policymakers regarding the nation's economic vulnerabilities in an era of geopolitical instability. Following the disruptions in the Strait of Hormuz, Rajan argues that India must urgently bolster its strategic reserves and rethink its supply chain dependencies to ensure long-term resilience.

Strengthening Energy Security and Strategic Reserves

Rajan emphasized that the Strait of Hormuz remains a critical vulnerability for India, given its significant share of the country’s crude oil, LNG, and LPG imports. He argued that even a potential US-Iran peace deal would not erase the fundamental risks exposed by recent maritime tensions. To mitigate this, Rajan called for the immediate expansion of India's strategic oil reserves.

Beyond oil, he suggested that India requires more flexible energy backup options. He pointed to China’s model of being able to rapidly ramp up coal production as a viable temporary measure. However, he cautioned that the transition to renewables is not a "silver bullet" due to new supply-chain risks; India remains heavily reliant on imported solar cells and wind components. He urged Indian industry to move beyond rhetoric and take a leading role in domestic manufacturing of these green technologies.

On the trade front, Rajan noted that while India is currently managing US tariff threats better than earlier this year, new risks are emerging. He highlighted a potential 12.5% tariff tied to forced-labor concerns—slightly higher than the 10% rates faced by neighbors like Pakistan and Bangladesh. More concerning is a separate "excess capacity" probe that could impose additional tariffs on Indian goods.

To defend against these shocks, Rajan’s primary recommendation is aggressive diversification. India must reduce its exposure by finding new sources for its imports and expanding its footprint in diverse export markets, ensuring that no single geopolitical event or trade policy can cripple the national economy.

Addressing the Rupee and Investment Gaps

Addressing the rupee’s 14% depreciation against the US dollar over the last two years, Rajan identified a structural issue rather than a simple commodity price problem. He noted a significant disconnect between India's strong headline GDP growth and the actual level of domestic and foreign direct investment (FDI). While remittance inflows remain robust, the lack of substantial FDI remains a concern.

He also offered a nuanced view on the current account, suggesting that if oil prices stabilize around $85 per barrel, India’s position is "relatively mild." He even cautioned that policymakers might be overreacting by considering expensive capital-inflow incentives, such as the FCNR(B) proposal.

Preparing for the Next Commodity Shock

Rajan concluded by urging a three-to-five-year strategic outlook. He warned that the next major vulnerability might not be energy, but rather critical pharmaceutical inputs used in generic drug manufacturing. He described the recent global shocks as a "wake-up call," urging the government to build strategic buffers and strengthen ties with "friendly supply countries" to prevent future economic paralysis.

Key Takeaways