The Indian economy is unlikely to significantly feel the effects of a widening Middle East conflict in the short term, owing to its strong macroeconomic fundamentals but will be impacted if the war is prolonged, say experts.

Iran, on October 1, launched ballistic missiles at Israel in retaliation to Israel’s war in Gaza, targeting Houthis in Yemen and Hezbollah in Lebanon.

Israeli Prime Minister Benjamin Netanyahu warned that Iran would “pay for its attack”.

Forex reserves India's bulwark

“There would be some economic impact for India, but, so far, domestic factors have been strong, which has kept the overall outlook strong,” said Paras Jasrai, senior analyst, India Ratings and Research.

Experts also indicate that record forex reserves are expected to protect India from immediate shocks.

"The geopolitical uncertainties and energy price volatility will have repercussions, if India's forex reserves were unstable. Given the sufficient reserves, the instantaneous repercussions will be negligible. The record rise in foreign exchange reserves… helps insulate the economy from macroeconomic uncertainties and such global shocks,” said Lekha Chakraborty, professor, National Institute of Public Finance and Policy (NIPFP).

India’s forex reserves surged to $692 billion for the week ending September 20.

According to official estimates, the economy is poised to grow 6.5-7 percent in FY25, while the RBI expects growth to be higher at 7.2 percent for the year.

“If the war is going to be short term, then no issue, but if it’s prolonged and there is a widening of conflict, it will be a risk. The impact on investments will delay global recovery, and India’s exports may be impacted,” NR Bhanumurthy, economist and Director of Madras School of Economics, told Moneycontrol.

The US warned Iran that it could face serious consequences of its missile attack on Israel.

Slowdown hits India’s manufacturing activity

The slowdown in exports has already impacted India’s manufacturing activity. Data released on October 1 showed that muted export growth and slow output brought the manufacturing PMI (Purchasing Managers' Index) to an eight-month low of 56.5.

Rising oil prices and commodity supply shocks could also upend inflation and current account dynamics.

Brent futures were up 1.13 percent to $74.4 per barrel on October 2.

“Oil prices have jumped by $5 in two days. It is a cause of concern for India that we depend heavily on imported oil,” said Bhanumurthy.

Iran accounts for 4 percent of global oil output, but the Organisation of Petroleum Exporting Countries (OPEC)-plus group, including Russia, have been planning a production increase in December, which could offset price rises.

Possible oil price rise a challenge

"A tit-for-tat escalation of the current events in an all-out war in the Middle East could sharply raise oil prices and intensify supply disruptions. This poses a risk for India’s current account, rupee and domestic inflation,” said Sakshi Gupta, principal economist, HDFC Bank.

A $10 rise in oil prices could increase the current account deficit by 30-40 bps and inflation by 20-30 bps.

India’s current account deficit widened to 1.1 percent in the first quarter of FY25, owing to a widening trade deficit. Experts, however, indicate that it will likely stay contained at around 1.2 percent for FY25.

Oil prices would have to witness significant jumps to impact the current account.

“Low demand from China has kept oil prices low. A further escalation could keep oil at $90/barrel. This would not be much of a problem, given that the global economy has become more resilient to such shocks. However, if oil price springs up beyond that, the current account could be around 1.5 percent of GDP, but it would still be manageable,” Jasrai added.

Beyond economy

"Iran and India are maintaining a strategic economic relationship. Hopefully, it does not turn into a full war. If it does, it will disrupt trade flows, especially oil, and delays in Chabahar port project, Iran-India Gas pipeline, etc.," Sri Hari Nayudu, economist, NIPFP, told Moneycontrol.

Chakraborty notes that a long-term impact would also depend on India's 'economic diplomacy'.