Raghuram Rajan on the Middle East war and its economic impact on India and the world?

ELI5/TLDR

Seventy days into the Israel-US war on Iran, the Strait of Hormuz is still effectively closed and buffer stocks of oil, gas and fertilizer are running down. Rajan reads the war as a miscalculation that nobody can win — Iran’s economy is wrecked, but so is the US recovery, and India sits exposed: half our oil and ninety per cent of our LPG came from the Gulf. Inflation is climbing, the rupee is sliding, and the government is still pretending it does not have to raise diesel and petrol prices. His verdict: hope and prayer is not a policy, and the longer this drags, the closer the world drifts toward genuine stagflation.

The Full Story

A war neither side knows how to leave

Rajan opens with a frame borrowed from Gideon Rose at Foreign Affairs — the dollar auction game. Two players bid for a dollar, but the second-highest bidder also has to pay what they bid. So the bidding climbs to thirty, forty dollars, because nobody wants to be the loser who paid for nothing. That is where the US, Israel and Iran are now. Neither side can be seen to be the one that gave in, and so each keeps raising the stakes past any rational price.

The original American and Israeli expectation was a short war and a quick Iranian capitulation. Instead, the moderates in Tehran have been killed off, the leadership that remains is more militant, and the Strait of Hormuz is shut. Both sides lose. Iran’s economy is in ruins and inflation is through the roof. The US is also bleeding — the AI and data-centre boom that was carrying the American economy needs helium for semiconductors and fertilizer for agriculture, both of which run through the Gulf. The K-shaped recovery Americans had been told was manageable is no longer manageable when poorer households are paying five dollars at the pump.

Trump as the unreflective belligerent

Asked about Trump’s behaviour — multiple contradictory justifications, threats to “annihilate Iranian civilization”, a fragile ceasefire he keeps undermining — Rajan is restrained but pointed. The administration did not think past the first few days. It was an opportunistic move to remove the Iranian leadership, probably nudged along by Israel. And once you are in, you cannot get out. Rajan reaches for an Indian analogy — the chakravyuh — the war formation from the Mahabharata that is easy to enter and almost impossible to escape.

He extends this into a broader point about authoritarian structures, the US included. In such systems, advisors stop offering the unvarnished truth. They read which way the wind is blowing and adjust. The leader, meanwhile, has already formed his views and rejects what does not fit. Both sides of the communication breakdown are at fault, and the result is large, avoidable mistakes — “including India’s own”.

India’s transactional drift

On Delhi’s response — no criticism of the US-Israel strikes, conspicuous delay in condoling the Ayatollah’s death — Rajan is clear that this is not real-politik well executed. It is a transactional foreign policy that has hollowed out the country’s standing. India takes whatever position suits the moment, untethered from any underlying values. Other countries no longer know what to expect from us, which is why we are peripheral to the negotiations even though we are ostensibly friendly with both sides. “We are chameleons.” We are running with the hares and hunting with the hounds, and neither side trusts us in the moment.

The shortage phase begins

On the world economy, Rajan reaches for the American line — “you ain’t seen nothing yet”. The early weeks of the war were cushioned by oil already in ships and on the high seas, including stocks that had been stuck under sanctions. That cushion is now gone. India had about fifty days of energy buffer. Other countries had less. From here on the world is dependent on actual flows through the Strait, and his estimate is that roughly twelve per cent of global oil and twelve to fifteen per cent of natural gas is being disrupted — enough to force genuine production shutdowns rather than the price-only adjustment we have seen so far.

Demand destruction of four to five million tons a day has happened. More is needed. In economies growing at two to three per cent, that kind of shortfall pushes you into recession quickly. The countries most exposed are those that import their energy — India and Europe — and within Asia and Africa, the poorest countries (Sri Lanka, Nepal) will get hit hardest because they have neither buffers nor buying power.

The mechanics of the squeeze on India

The double whammy on India is by design, not accident. The rupee is depreciating because the current account deficit is widening, and the depreciation is the market’s way of forcing Indians to buy less oil. It is the price mechanism doing what the government will not.

Diesel and petrol prices have been held flat through the election season. Oil marketing companies have been absorbing the losses. That can continue for a while, but only until the fiscal cost becomes intolerable. With elections done, Rajan expects the government to be forced into a pass-through within ten to twenty days. The longer it waits, the steeper the eventual adjustment. The pattern is familiar to anyone who has watched Indian fuel pricing — keep the price flat when global prices spike, keep it flat when global prices fall, and let the oil marketers eventually recover the losses. Except in a scenario where prices could double again to $170-180 a barrel, that game runs out of room.

Cooking gas has already been rationed away from commercial users — restaurant cylinder prices have gone from Rs 1,700 to over Rs 3,000. But every such rationing has second-order costs. Push restaurants to close and the workers go back to their villages, and getting them back into urban work is hard, the way it was after COVID.

Fertilizer and the monsoon

Beyond oil and gas, the Gulf supplies India with fertilizer, sulfur and helium. Fertilizer is the immediate problem because the monsoon is three weeks from Kerala, the forecast is for a weaker monsoon (El Nino), and farmers are among the most vulnerable segments. The government will almost certainly subsidize fertilizer prices, but Rajan flags the harder question — what happens when there are not just expensive supplies but actual shortages? How do you ration fertilizer across millions of farmers? He sees no public plan from the government on this, and his read of the government’s posture is “hope and prayer that somehow it doesn’t have to react”.

The Gulf as Singapore-of-the-west

On the longer-term damage to the Gulf economies — 10 million Indian workers, half our remittances — Rajan says it depends almost entirely on the nature of the peace. A comprehensive settlement that resolves both the Iranian nuclear question and Israel’s “mowing the lawn” doctrine could let Dubai reemerge as the Singapore of the region, maybe to ninety per cent of where it was. A fragile peace where war could resume at any time will hit tourism, transit traffic and investment hard. Even in the good scenario, fertilizer buyers who depended on the Gulf will quietly look for alternatives, and there will be a rush to build pipelines that bypass the Strait.

The regime question

The interview closes on Iran’s regime. Rajan thinks it survives — embittered, more militant than before, with the moderates dead. He does not rule out an Iranian people fed up with economic hardship eventually pushing back, but the path from the current regime to a liberal democratic one is “long”.

Key Takeaways

The dollar-auction frame is the key analytical move — both sides keep escalating not because they are winning but because neither can be seen to lose
Rajan’s quantified estimate: 12% of global oil, 12-15% of natural gas disrupted; enough to force production shutdowns, not just price adjustments
India’s buffer was ~50 days. Most of it is now gone. The shortage phase has begun.
The rupee depreciation is the demand-destruction mechanism — it is doing the rationing the government refuses to do via pump prices
The diesel/petrol price freeze can’t last; expect pass-through within 10-20 days of the election finishing
Fertilizer + weak monsoon is the agricultural overlay nobody is talking about enough
Rajan’s diagnosis of authoritarian decision-making — advisors stop telling the truth, leaders reject what they don’t want to hear — is offered for the US but is plainly meant for India too
Best case for the Gulf is a comprehensive peace; even then, only 90% recovery, and customers will diversify away
Iran’s regime survives. The moderates are dead. Whatever comes next will be harder to negotiate with.

Claude’s Take

This is Rajan at his most useful — not the maverick ex-RBI governor talking politics, but the macro economist with operational intuition for how things actually break. The dollar-auction frame is genuinely clarifying because it explains why the war keeps not ending despite both sides knowing they are losing. The numbers he offers — 12% global oil, 12-15% gas, 50-day Indian buffer, 4-5 million tons of demand destruction — are the kind of texture you cannot get from headlines.

The strongest section is the one on the rupee. Most commentary frames currency depreciation as a problem to be solved. Rajan reframes it as the policy tool that is actually working — the price mechanism doing the demand destruction the government refuses to do at the pump. That is a useful inversion. It also tells you what to watch: if the government starts intervening heavily to defend the rupee while still holding pump prices flat, both signals are being suppressed simultaneously and the eventual adjustment will be brutal.

He pulls his political punches where he has to — at Trump, at the Modi government — but the framing of “authoritarian structures lead to bad decisions because advisors don’t tell the truth” lands without him having to spell out the parallel. The line about India being “chameleons” running with the hares and hunting with the hounds is the sharpest he gets, and it is sharp.

The interview’s main gap is that Karan Thapar pushes Rajan to predict things he sensibly refuses to predict — the GDP growth number for FY27, whether hostilities resume. Rajan’s “I’d be nutty to give you a number” is the right answer; we are in a regime with no historical analogue. The 1973 oil shock comparison is useful but the IEA’s claim that this is worse is probably correct — 1973 was a quintuple in price; this is on track for a similar move but starting from a higher base and with global supply chains far more interlinked.

Score 8/10. The reason it is not higher is that Thapar’s interview format does not let Rajan develop the analytical depth he is capable of — every answer is two to three paragraphs before the next prompt. The reason it is not lower is that the substance is dense, the numbers are real, and the framing tools (dollar auction, chakravyuh, K-shaped recovery turning genuine) are the kind you keep using long after the war is over.