By DK AggarwalHeightened geopolitical tension in West Asia returned to haunt markets this week, after Iranian armed forces shot down an American drone.
Tension has been rising in the region, home to over 20 per cent of the worlds oil output, after attacks on two tankers near the Strait of Hormuz, which raised concerns about possible disruptions in oil supplies.This kind of tension between Iran and the US is not new.
In 1988, the US had launched a significant military operation against Iran, code-named Operation Praying Mantis, and swiftly destroyed multiple Iranian oil platforms, sea bases and ships, sending crude oil prices soaring.
Oil prices remained elevated throughout 1980-1985, as two major oil producers Iran and Iraq engaged in a protracted war, which often spilled over to the sea and disrupted oil tanker movement.
Incidentally, crude oil remained a bone of contention between the two countries for decades.To boot, Iran and the US have had no formal diplomatic relations since 1980.
Last year, the US shredded the 2015 nuclear agreement with Iran, reimposed sanctions and ended waivers on Iranian crude imports.
The shooting down of US military drone by Iran marks the latest escalation in tensions between the two nations.There is fear among market participants that the tension could escalate, as there are no signs of the two nations coming together for talks anytime soon.
The silver-lining is that after giving go attack signal to the US Army this week, the Trump administration called back them at the last moment.The US says it would take every action necessary, including diplomatic, to guarantee safe navigation in West Asia.
The US itself is no longer dependent on the oil flow from the Gulf.
But the escalation of tension may interrupt shipping through the Strait of Hormuz (the Strait), a key route of the global oil market, and significantly affect global oil prices.Though most of the oil that flows through the Strait comes to Asia Pacific, Europe and North America, the oil market is globally integrated and a disruption anywhere can contribute to higher oil prices everywhere.Crude oil prices have already started a northward journey after remaining calm for the past few years on demand improvement in the US and as Opec and other producers agreed on a date to discuss output cuts.
A US-China meeting at G-20 to ease trade tension, which was threatening global growth, is another positive for crude oil.If the tension in West Asia does not ease quickly, it may become a cause for inflation to accelerate, posing a challenge for the economies dependant on oil imports.Monetary policymakers the world over are taking note of the latest spike in crude oil prices.
The challenges to global growth have already made central bankers across Asia, Europe and North America to turn dovish in their outlook.
Going ahead, we may see a further extension of easy money policies to spur growth.
In such a scenario, we may see easy liquidity return to financial markets, especially developing economies such as India, leading to a spike in asset prices.
Chairman and MD, SMC Investments and Advisors