The Impact of an Israel-Iran Conflict on India: Trade Disruptions, Rising Shipping Costs, and Risks to the India-Middle East-Europe Economic Corridor"

The ongoing tensions in West Asia, particularly between Israel and Iran, have garnered global attention. These developments are not just significant in terms of military and political outcomes, but also for their profound implications on international trade and economics. For a country like India, which has strong trade ties with the Middle East, Europe, and Africa, this conflict poses a host of challenges. From longer shipping routes and higher freight rates to uncertainties in the emerging India-Middle East-Europe Economic Corridor (IMEC), the effects of an Israel-Iran direct conflict are substantial.

1. Overview of the Conflict and its Escalation

At the heart of this conflict lies the long-standing enmity between Israel and Iran. While the military operations often take center stage, their broader economic impact cannot be overlooked. Hezbollah, a powerful Iranian proxy in Lebanon, and the Houthis in Yemen have been directly involved in disrupting trade routes, particularly the Red Sea shipping lane.

Recent months have seen increased missile attacks and naval skirmishes in the region, pushing global traders into a state of caution. The strategic Red Sea route, vital for India’s trade with Europe, the US, and Africa, is under threat due to possible blockades or outright attacks on commercial vessels.

2. Impact on Global and Indian Trade Routes

For Indian exporters, the Red Sea is an indispensable maritime corridor. Approximately 10-15% of India’s global trade passes through the Suez Canal, connecting the Arabian Sea to Europe. The Hezbollah-Houthi alliance and escalating military activity in the region now pose significant risks to this essential trade route. A blocked Red Sea would force vessels to reroute around the Cape of Good Hope, significantly extending travel time and escalating costs.

Key Consequences:

• Increased Freight Costs: Rerouting vessels adds to fuel and insurance costs, leading to 15-20% higher shipping rates.
• Longer Transit Times: Ships taking the longer route around Africa face delays of several days or even weeks.
• Higher Commodity Prices: With increased transport costs, the final prices of essential goods such as oil, engineering products, and textiles are likely to surge.

3. The Role of the India-Middle East-Europe Economic Corridor (IMEC)

Announced with great fanfare, the India-Middle East-Europe Economic Corridor (IMEC) is poised to be a game-changer in global trade. This ambitious infrastructure project, designed to connect India to Europe through the Middle East, is now under strain due to the ongoing Israel-Iran conflict.

The IMEC is part of India’s broader strategy to diversify its trade routes and reduce dependency on the traditional maritime lanes like the Red Sea. However, with military tensions rising in the region, the corridor’s viability and safety have come into question. Any further escalation could delay construction, raise costs, or deter global investors.

4. India's Petroleum Exports Under Threat

One of the immediate impacts of the conflict has been felt in India’s petroleum exports. August 2024 saw a 38% drop in petroleum exports, largely attributed to disruptions in the Red Sea route. India, which is heavily reliant on the Middle East for crude oil imports, is now facing a potential supply chain crisis.

Exporters are being forced to look for alternative markets or adjust their supply chains, both of which come with higher operational costs. Europe, which accounted for over 21% of India’s petroleum exports in FY23, may see a reduction in shipments if the conflict continues to escalate.

5. Impact on Engineering Goods and MSMEs

India’s Micro, Small, and Medium Enterprises (MSMEs) are particularly vulnerable to the rising freight costs. Many MSMEs rely on low-margin, high-volume exports of products such as textiles, garments, and engineering goods. With shipping costs spiking, their profit margins have already begun to shrink.

This increase in operational costs is likely to affect their ability to compete in international markets, where buyers can easily shift to cheaper suppliers in other regions. The global shipping industry itself, dominated by major players such as Maersk, has capitalized on the situation, raising rates due to high demand and limited capacity.

6. Iran's Role in the Conflict and Trade Implications for India

While Iran has always been a significant player in West Asia, the current conflict puts it at the center of attention for both its military activities and its impact on trade routes. India’s historical ties with Iran, especially through the Chabahar Port project, could provide an alternative trade route, bypassing the Suez Canal. However, India’s balancing act in maintaining relations with both Israel and Iran will be tested.

If the conflict worsens, India may face increased sanctions or diplomatic pressure from Western powers, affecting its trade relations with both Iran and its broader global partnerships.

7. Risk to India's Food and Energy Security

The Red Sea crisis and its resulting trade disruptions have raised concerns about India’s food and energy security. Much of India’s food imports, particularly grains and edible oils, are sourced from Ukraine, Russia, and other European nations. With longer shipping times and elevated freight rates, food prices in India could spike, further aggravating inflation.

Similarly, disruptions in crude oil supplies from Iran, Saudi Arabia, and other Gulf nations could lead to fuel shortages or higher prices in India. This is particularly concerning given India’s reliance on the Middle East for over 60% of its crude oil imports.

8. Silver Linings Amidst the Crisis

Despite the challenges, there are some silver linings for India. The neutral stance of key Gulf nations such as Saudi Arabia, the UAE, Kuwait, and Qatar has allowed India’s trade relations with these countries to thrive, even as the Israel-Iran conflict escalates.

A 17.8% increase in trade between India and GCC countries in 2024 shows resilience, suggesting that these nations may continue to serve as reliable trade partners. Moreover, India's exports to Iran saw a 15.2% growth despite the conflict, indicating potential opportunities for further engagement.

9. The Potential for Regional Stability

While the situation remains volatile, there is cautious optimism among analysts that a regional diplomatic solution may eventually emerge. Should Israel succeed in neutralizing Hezbollah and the Houthis, the key instigators of trade disruptions, the Red Sea may once again become a viable and safe trade route. This could quickly lead to a reduction in freight rates and stabilize the global supply chain.

10. India's Strategic Response: Building a National Shipping Line

Indian exporters, particularly those in the MSME sector, have been advocating for the creation of a national shipping line. With the dominance of foreign shipping companies, Indian traders face rising remittance costs. In 2022 alone, India’s outward remittance for transport services exceeded $109 billion. A domestic shipping line would reduce dependency on foreign players and stabilize the costs of international trade.

Conclusion

The Israel-Iran conflict has far-reaching implications for India’s trade and economic landscape. From rising shipping costs and disrupted trade routes to the potential delays in the India-Middle East-Europe Economic Corridor, the challenges are numerous. However, amid the crisis, opportunities for further cooperation with neutral Gulf nations and a strategic focus on self-reliance in shipping can mitigate some of the risks. India’s trade policies and diplomatic strategies will play a crucial role in navigating these uncertain waters.