Raghuram Rajan Warns India: Build Oil Reserves and Diversify Faster

Economist Raghuram Rajan has issued a critical warning to Indian policymakers, suggesting that recent geopolitical tensions in the Strait of Hormuz serve as a wake-up call for the nation's energy security. He argues that while headline trade volumes remain stable, the cumulative impact of disrupted trade routes and shifting tariff regimes requires a fundamental rethink of India's economic resilience.

Strengthening Energy Security and Strategic Reserves

Rajan highlighted that the Strait of Hormuz is a vital artery for India’s energy needs, accounting for a significant portion of its crude oil, LNG, and LPG imports. He emphasized that even the possibility of a US-Iran peace deal should not lull the country into a false sense of security. To mitigate the risk of sudden supply disruptions, Rajan argued that India must aggressively expand its 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 potential short-term stabilizer. However, he also cautioned that the transition to renewables is not a silver bullet; India currently faces significant supply-chain risks due to its heavy reliance on imported solar cells and wind components. Rajan called for Indian industry to take a more proactive role in manufacturing these domestic alternatives.

On the trade front, Rajan noted that while India is in a better position than earlier this year, new challenges loom. He flagged an incoming 12.5% tariff tied to forced-labor concerns—a rate slightly higher than the 10% faced by neighbors like Pakistan and Bangladesh. Of greater concern is a potential "excess capacity" probe that could lead to additional, stacked tariffs.

To counter these vulnerabilities, Rajan’s primary recommendation is diversification. India must move away from over-reliance on single import sources and single export markets. He also warned that the next major vulnerability might not be energy, but the pharmaceutical sector, specifically the reliance on imported inputs for manufacturing generic drugs.

Addressing the Rupee and Investment Gaps

Rajan also addressed 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 decline is not merely a byproduct of oil prices but a symptom 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 economic potential and domestic investment. He cautioned policymakers against overreacting with costly incentives, such as the FCNR(B) proposal, suggesting that if global oil prices stabilize around $85 a barrel, the current account position remains relatively manageable.

Key Takeaways