Raghuram Rajan Warns India to Build Oil Reserves and Diversify Trade

Economist Raghuram Rajan has issued a critical warning to Indian policymakers, stating that recent geopolitical disruptions like the Strait of Hormuz crisis serve as a vital wake-up call. He argues that while headline trade volumes remain stable, the cumulative impact of disrupted routes and tariff battles necessitates a fundamental shift toward economic resilience.

Strengthening Energy Security and Strategic Reserves

Rajan emphasized that India’s vulnerability to energy supply shocks remains high because the Strait of Hormuz is a primary conduit for the country's crude oil, LNG, and LPG imports. He stated bluntly that a potential US-Iran peace deal is not a permanent solution to this underlying risk. To mitigate this, Rajan advocated 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 during crises as a potential template. While he supports a long-term transition to renewables, Rajan cautioned that the green transition brings its own supply-chain risks, as India remains heavily reliant on imported solar cells and wind components. He urged Indian industry to take a more proactive role in domestic manufacturing to solve this dependency.

On the trade front, Rajan noted that India is currently managing US tariff threats better than earlier this year. However, he flagged specific risks, including an incoming 12.5% tariff tied to forced-labor concerns—a rate slightly higher than the 10% faced by Pakistan and Bangladesh. A more significant threat, he warned, is a potential "excess capacity" probe that could lead to additional stacked tariffs.

To protect the economy from such volatility, Rajan’s core recommendation is twofold: India must diversify its import sources to avoid over-reliance on specific regions and expand its export markets to reduce exposure to any single geopolitical shock.

Addressing the Rupee and the FDI Gap

Rajan also addressed the structural issues behind the rupee’s nearly 14% depreciation against the US dollar over the last two years. He argued that the currency's slide is not merely a byproduct of oil prices but a reflection of India's struggle to attract sufficient Foreign Direct Investment (FDI).

Despite strong headline GDP growth and robust remittance inflows, Rajan noted a disconnect between India's economic potential and actual domestic investment. He questioned why high growth hasn't translated into higher investment levels, suggesting that policymakers need to bridge this gap. Interestingly, he suggested that if oil prices stabilize around $85 per barrel, the current account position remains "relatively mild," implying that some recent policy reactions might be overcautious.

Future Risks: From Oil to Pharmaceuticals

Looking ahead, Rajan advised a three-to-five-year strategic view on commodity exposure. He warned that the next major vulnerability for India might not be energy, but the supply of pharmaceutical inputs used in generic drug manufacturing. He urged the government to build strategic buffers and strengthen ties with friendly supply nations to safeguard critical sectors.

Key Takeaways