Indian markets may be underestimating the Iran effect
The drone attack that killed Soleimani, a senior military official of Iran may have much larger repercussions than is being currently envisaged. In the fractured Middle East, this may appear to be a normal event but it is the first time that the American drones have directly attacked a senior military official and Iran is likely to retaliate. While the oil prices and the stock markets surely reacted, the event could have larger implications for markets. Here is why.
Oil is the immediate worry
Oil prices in the Brent crude market were up by 4% in the immediate after-math of the bombings. That was bound to happen considering that Iran controls the Strait of Hormuz which moves nearly 30% of the world oil. In the past, Iran had intercepted ships in the Strait of Hormuz and many ships may choose to take circuitous routes to their destinations. This could lead to higher costs and push oil prices higher. Secondly, the problem for India is a little more complicated. India relies on oil imports for nearly 80% of its daily needs and that could see a huge spurt if the crude prices go up. It also has macro implications. The trade deficit and current account deficit have been under check in the last few months due to lower oil prices and that could drastically change if the oil prices got closer to $70/bbl. In the past it has been seen that a sharp spike in oil prices has led to higher deficits and higher inflation.
Impact on stocks
There are a large number of stocks that could get impacted by the rise in oil prices. For example, aviation stocks are the most vulnerable to a spike in oil prices. Most airline companies are very vulnerable to oil price spikes since ATF accounts for nearly 60% of the operating cost of the airline. None of the airline companies are able to pass on their costs to the customer due to the high degree of competition in the industry. Secondly, downstream oil companies are also at risk. Stocks like BPCL and HPCL are normally asked to bear a part of the subsidy burden to ensure that the pressure on the end consumer is not too much. Lastly, there are a number of companies like paints, automobiles and transport which are closely related to the price of petrol and diesel. Their demand normally takes a hit if the price increases above a certain point. All these can have a significant impact on the stock markets.
India may be underestimating
The moral of the story is that India may have largely underestimated the impact of the oil price hike. India is likely to feel the pinch at multiple levels and the markets may not be fully reacting in the midst of all the euphoria surrounding the markets. Iran may be symptomatic of long term volatility in oil prices and that is not great news for the Indian economy and the markets too!
