How will the closure of the strait of Hormuz affect the economy? Crucially, this depends on how long it stays closed. Because the effect is not linear. Initially, the effects are small. They grow slowly. At some point, the effects get bigger. And eventually, it’s large enough to cause an economic crisis.
The best analogy is to imagine a pot of boiling water. When the stove starts, the water gets warm. At some point, the water gets hot enough that it starts to boil. If the stove is turned off before the water boils, nothing is lost. But if not, all the water is gone. If water represents the economy and the fire is the closure of the straight, we are not yet at boiling point. But we are close.
The role of inventories
The closure of the strait has resulted in a decline in oil production of around 11 million barrels per day. This represents approximately 10% of daily total. But we have not yet experienced a similar drop in consumption. This is because of existing stocks and reserves. In response to the production decline, inventories have been drawn down.
The energy information agency estimates that inventories declined by 246 million barrels in March and April, around 4 million barrels per day. This means that between one third and one half of the production decline is offset by drawing down inventory.
The drawdown has cushioned the blow from supply disruptions. It is the reason the crude oil price is around $100 today, instead of $150 or higher. Despite the rise in oil prices, prices today are still much lower than their all-time high of nearly $150 reached in 2008.
As of 2025, total global oil inventories were 2 billion barrels. At the current rate of decline, inventories would be exhausted by the end of the year. Oil prices would likely spike well in advance of this, if inventories continue to be depleted.
The elasticity of oil demand is approximately -0.2. This means that prices must rise by 1% for demand to fall by -0.2%. So for demand to fall by 10%, prices need to rise by 50%. Once the inventory drawdown is complete, we can expect prices to settle closer to $150 from current levels.
How the oil shock spreads
Oil imports are roughly 5% of India’s GDP. A 50% increase in prices means that imports go up to 7.5%. This adds directly into the current account. The current account deficit was 1.3% in 2025, and this increase would widen it somewhere between 2% and 3%.
The widening current account deficit puts direct pressure on the rupee. Indeed, we are already witnessing cracks in the currency market. The rupee is already down about 6% since the start of the conflict, despite repeated intervention in the currency market. On Thursday, the RBI stepped into the currency market, selling $2-$3 billion dollars to stabilize the rupee. The RBI cannot keep doing this without running out of dollars to sell. As a result, the RBI is now weighing interest rate hikes to stabilize the currency.
Inflation is the next culprit
The knock-on effects of higher oil prices are a weaker rupee are inflation. As of now, inflation remains low. But inflation is likely to rise in a big way. In fact, this first indication of this has just occurred. Wholesale inflation rose to 8.3% in April, compared to 3.88% in March. In the next three months, this wholesale inflation will end up as consumer inflation.
Whatever effects we observe today – this is not the water boiling. This is the water hot enough that steam is evaporating. This is the brewing of an economic crisis. The coming crisis is not specific to India. It is global. Every country is affected, but oil importing countries are hit the most.
What can policy makers do?
The most important thing is not let inflation get out of hand. Inflation, once it takes off, is difficult to tame. And high inflation kills economic confidence. This means interest rates need will need to go up. And in the process, economic activity will slow down. This means declining incomes and job losses.
Keeping a lid on inflation is the best way to absorb the shock and retain confidence in the economy. This allows the recovery to begin as soon as possible. If oil prices remain high for a long time, this will incentivize alternative sources of energy, further aiding any future recovery.
The looming crisis may well be averted. After all, this is a crisis due to political and military decisions. And these are decisions that can be changed. The economic pressure may be what’s needed to end the West Asia conflict.
Disclaimer:
Note: The purpose of this article is to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly encouraged to consult your advisor. This article is for strictly educative purposes only.
Asad Dossani is an assistant professor of finance at Colorado State University. His research covers derivatives, forecasting, monetary policy, currencies, and commodities. He has a PhD in Economics. He has previously worked as a research analyst at Equitymaster, and as a financial analyst at Deutsche Bank.