US-Iran conflict scare puts markets on edge, oil prices likely to go up

A protester outside the Federal Courthouse in St Louis in the US on Saturday. Photo: PTI
Market participants are bracing themselves for heightened volatility as escalating tensions between the US and Iran are threatening to disrupt macroeconomic conditions, with oil prices likely to go up amid possibilities of a full-blown conflict between two of the biggest oil-producing nations. 

“Given India’s sensitivity to global crude oil prices, any sustained spike led by geopolitical risks may naturally lead to depreciation pressure on the rupee and increase in bond yields, with other things being equal,” said Kaushik Das, India chief economist, Deutsche Bank. “Volatility will rise in the coming weeks and months,” added Das. 

On Friday, Brent crude closed 3.5 per cent higher at $68.96 per barrel after the US confirmed the success of its drone strike, killing Qassem Suleimani, commander of Iranian forces.

Currency experts fear the rupee could react in the coming sessions, which may trigger a heavy pull-out by foreign portfolio investors (FPIs), looking to avoid the impact of currency volatility on their returns.

“A volatile rupee would spook FPIs at a time when we desperately need foreign demand, especially in the bond markets. The rupee at 72.75 is likely to act as resistance for dollar-rupee in the medium term. At 71.20, there is a strong support on the downside,” said Abhishek Goenka, managing director at IFA Global, a foreign exchange advisory firm. 

For the equity markets, a reversal in FPI flows can lead to broad-based selling as overseas investors bought in Rs 1.01 trillion worth of equities in 2019, which was 2.4x the investments made by domestic institutional investors. 

On Friday, the rupee depreciated by 0.61 per cent against the dollar, closing at Rs 71.81.

Equity-market experts expect foreign investors to remain nervous vis-à-vis their allocation for India and other emerging markets (EMs). “Foreign investors can turn to less risky assets. And EMs tend to be prime candidates for investor pull-backs whenever there is a risk-off trade,” said U R Bhat, director at Dalton Capital Advisors. 

“If this escalates, it won’t bode well for India. Even a $1 spike in the crude oil price translates into a significant addition to the import bill. Further, it will put pressure on inflation and the fiscal deficit and lead to an overall environment of uncertainty,” said Jigar Shah, chief executive officer, Maybank Kim Eng Securities. Oil is among the top items on India’s import bill and a spike in prices can further widen the fiscal deficit. There were signs of risk-aversion in global markets on Friday, with gold spot prices closing 1.5 per cent higher at $1,552.2 per ounce. The Dow Jones Industrial Average (DJIA) and Nasdaq — the two benchmark gauges for US stock markets — closed 0.8 per cent and 0.79 per cent lower on Friday, respectively. This was the sharpest decline for the DJIA and Nasdaq since early December. Analysts say the Union Budget, expected on February 1, will have to factor in risks to macroeconomic conditions posed by the stand-off between the US and Iran.

Meanwhile, the Asian markets are yet to show any major signs of panic, but experts say this could change in the coming weeks. The Shanghai Composite closed marginally lower on Friday. The Korea Composite Stock Price Index (KOSPI) and Taiwan TAIEX ended slightly positive. Back home, the Nifty50 and BSE Sensex closed 0.4 per cent lower. Experts say the domestic bond markets can also feel strong tremors of the ongoing brinkmanship between the US and Iran.

“The bond prices could come under pressure if geopolitical tensions flare up and if oil remains at elevated levels for a longer period of time,” said Hemal Doshi, vice-president, treasury, SBI DFHI, a primary dealer. For India, the stakes are high due to its sensitivity to crude oil, and its linkages to several other economic indicators.

“Beyond $75 per barrel, Brent would certainly begin to unnerve investors,” said Goenka. 

Domestic fund managers had held a more confident outlook as global macroeconomic variables had turned more favourable in the past few months. However, now there is a note of caution. 

“Commodity prices have been inching up because of factors such as easy liquidity and the China stimulus. And now suddenly, geopolitical risks are also putting upward pressure on energy prices,” said Navneet Munot, chief investment officer, SBI Mutual Fund (MF).  

Some fund managers say it is still too early to predict things. 

“The increase in geopolitical risks will have a limited impact on the markets unless crude oil prices move above $80 per barrel on a sustained basis, which appears unlikely,” said Neelesh Surana, chief investment officer, Mirae MF.

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