Media365
The first casualty of every West Asia conflict is usually the oil market. The second is often overlooked. As crude prices climb on fears of supply disruptions, investors are piling into the US dollar, betting that higher energy costs will keep inflation elevated and force the Federal Reserve to stay hawkish. For India, that could be a more enduring challenge than expensive oil itself, because a stronger dollar has the potential to weaken the rupee, inflate import costs and complicate every major economic decision — from inflation management to interest rates.
For India, every flare-up in West Asia has traditionally meant one thing: higher crude prices and a bigger import bill. As one of the world’s largest oil importers, the country has long been vulnerable to disruptions in global energy markets.
But the latest escalation between the United States and Iran is highlighting a second, less obvious risk. Alongside the surge in oil prices after fresh US strikes on Iranian targets, global investors are rushing into the safety of the US dollar. That shift could prove more damaging for India over time than crude alone, because a stronger dollar can weaken the rupee, raise the cost of imports, trigger capital outflows and narrow the Reserve Bank of India’s room to support growth.
A geopolitical shock is lifting the dollar
The latest round of hostilities has once again reminded markets why the US dollar remains the world’s preferred safe-haven currency.
The US military launched fresh strikes on Iran after President Donald Trump said an interim agreement to end the conflict was “over”, pushing Brent crude close to $79 a barrel and reviving fears of a prolonged disruption around the Strait of Hormuz. Nearly one-fifth of global oil and liquefied natural gas supplies pass through the strategic waterway.
As oil prices rose, investors began reassessing the inflation outlook. Higher energy costs are expected to feed into consumer prices globally, prompting markets to bet that the US Federal Reserve may have to stay tighter for longer rather than ease financial conditions.
That combination — geopolitical uncertainty, rising Treasury yields and expectations of higher US interest rates — has strengthened demand for the dollar. The dollar index remained near 101 on Thursday, while the Japanese yen weakened sharply and the US currency hovered near its strongest level against the Japanese currency in a week.
Market expectations have shifted quickly. According to CME FedWatch data, traders are now pricing in an 87 per cent probability of another Federal Reserve rate hike this year after hawkish minutes from the US central bank’s June policy meeting.
Why the dollar matters more than oil
India has become better prepared to absorb oil shocks over the years by diversifying crude imports, building foreign exchange reserves and improving its external balance.
The stronger dollar, however, creates a broader and more persistent macroeconomic challenge.
Most globally traded commodities — including crude oil, liquefied natural gas, fertilisers and industrial raw materials — are priced in dollars. That means every rise in the US currency increases India’s import costs even if commodity prices themselves do not move much.
A stronger dollar also raises the repayment burden for companies with foreign currency borrowings, makes overseas travel and education more expensive, and often pushes global investors to shift money out of emerging markets and into higher-yielding US assets.
The result is pressure on the rupee, higher imported inflation and tighter financial conditions.
Unlike an oil price spike, which may ease if geopolitical tensions cool, a strong dollar can remain elevated for months if US interest rates stay high.
Pressure is already showing up in the rupee
The rupee has already begun reflecting these global pressures.
After slipping to a one-month low following the renewed escalation in West Asia, the Indian currency recovered modestly on Thursday as likely intervention by the Reserve Bank of India through state-run banks helped stabilise the market.
The rupee traded around 95.40 against the dollar after dollar sales by state-run banks, widely seen as acting on behalf of the RBI, offset some of the pressure created by higher crude prices and renewed geopolitical uncertainty.
Currency market participants believe the central bank is focused on preventing excessive volatility rather than defending any particular exchange rate.
Analysts warn that if the dollar remains strong, the rupee could stay under pressure even if oil prices stabilise.
As one market participant put it, when oil sneezes India catches a cold—but when oil and the dollar rise together, the economic impact becomes much harder to manage.
The RBI’s balancing act is getting harder
The Reserve Bank of India now faces a more complicated policy challenge than during previous oil shocks.
Higher oil prices tend to lift inflation directly through fuel costs while also increasing transportation and logistics expenses across the economy. A stronger dollar amplifies those pressures by making imports more expensive and weakening the rupee.
At the same time, raising interest rates aggressively to defend the currency could hurt domestic growth just as businesses are already dealing with higher input costs.
Recent market positioning reflects that dilemma.
Only weeks ago, foreign investors were betting on a rapid series of RBI rate increases amid concerns over inflation and rupee weakness. Those expectations have since eased sharply after the central bank introduced measures to attract foreign capital and support the currency without resorting to aggressive monetary tightening.
Trading volumes in India’s five-year overnight index swap market have surged to record highs as investors unwind earlier expectations of steep rate hikes, signalling greater confidence that the RBI can use multiple policy tools to manage currency pressures.
But renewed geopolitical tensions threaten to complicate that outlook once again.
Inflation risks are building
The timing could hardly be worse.
Economists now expect India’s consumer inflation to move above the RBI’s 4 per cent medium-term target in June for the first time in 16 months, driven by firmer food prices, elevated fuel costs and concerns over the impact of the US-Iran conflict.
A Reuters poll of economists projected headline inflation at 4.3 per cent in June, up from 3.93 per cent in May.
Wholesale inflation is also expected to remain elevated as higher global energy prices feed into producer costs, although economists believe the pass-through to retail inflation may be gradual.
Still, renewed oil volatility adds another upside risk to the inflation outlook, especially if tensions around the Strait of Hormuz persist.
Markets are beginning to price in the new reality
Indian equity markets offered an early glimpse of how investors are interpreting the changing macro picture.
Benchmark indices rebounded on Thursday after suffering their steepest one-day decline in three months, with investors selectively buying beaten-down stocks.
The recovery, however, was cautious.
Defensive sectors such as pharmaceuticals and healthcare attracted buying interest, while companies more exposed to rising energy costs remained under pressure. Market participants said future earnings guidance, developments in the US-Iran conflict and the trajectory of oil prices would determine whether the recovery can be sustained.
A broader macroeconomic challenge
India has weathered oil shocks before.
What makes the current episode different is that the country is confronting two intertwined risks rather than one.
Higher crude prices threaten to widen the current account deficit and push inflation higher. A stronger dollar magnifies those pressures by weakening the rupee, increasing import costs, tightening global liquidity and making it harder for the RBI to balance inflation control with economic growth.
That is why the latest crisis in West Asia is no longer just an oil story.
It is increasingly becoming a dollar story — and for India, that may ultimately prove to be the more consequential economic challenge.
