KUALA LUMPUR (BLOOMBERG) - A brewing diplomatic spat between India and Malaysia has got an unusual victim caught in the crossfire: palm oil.

New Delhi abruptly restricted imports of refined palm oils this month, apparently irked by Malaysian Premier Mahathir Mohamad's comments on steps taken by the administration of Indian Prime Minister Narendra Modi that affect Muslims in India.

The South Asian country is the world's biggest palm buyer and is a major market for Malaysia, the No. 2 producer.

While India didn't publicly say the move was in retaliation to Tun Dr Mahathir's comments, the South-east Asian nation counts refined palm oil as an integral part of its economy and any loss in sales will deal a huge blow.

If India's refined imports from the nation drops from about 2.6 million tonnes a year to reach to 2018 levels, about two million tonnes of Malaysian processed products worth US$1.4 billion (S$1.89 billion) may need new buyers, said Mr Khor Yu Leng, an independent economist with Segi Enam Advisors, who has published papers on Malaysia's political economy.

Tensions between the two countries began in September when Dr Mahathir told the United Nations that India "invaded and occupied" Kashmir and later criticised India's citizenship amendment act.

His comments made the Modi government uneasy and led to an influential processors' group in Mumbai asking its members to avoid buying palm oil from Malaysia.

The Indian government has also informally told local importers to avoid purchasing crude palm oil from Malaysia, according to traders and industry officials, who asked not to be identified due to the sensitivity of the matter. The spokesman for the commerce ministry was not immediately available for comment.

Since then, many Indian palm oil buyers have started shifting to Indonesia amid concerns that Mr Modi's government may restrict purchases from Malaysia or hike import taxes.

The rift may not only hit Malaysia, but also hurt Indian consumers, as suppliers from Indonesia have started charging a premium of US$15-US$20 per tonne over benchmark prices, traders said.

Although Malaysia has said it will raise its export duty on crude palm oil to 6 per cent in February from 5 per cent a month earlier, analysts said it may come under pressure to cut the levy.

"If India doesn't buy from Malaysia, the country has to find other buyers," said Mr Oscar Tjakra, analyst at Rabobank International in Singapore. "Malaysia may have to change its export duties to remain attractive."

Palm may average at RM2,950 (S$977) per tonne in the first quarter and at RM2,750 in the April-June period, Mr Tjarka said. That compares with an average of RM2,588 during the October-December quarter.

To minimise the blow, Malaysia has started promoting its palm oil in other markets. Primary Industries Minister Teresa Kok said during a recent visit to Pakistan that both the countries were planning to improve trade in palm oil and other commodities.

While Malaysia will use diplomatic channels to reach a solution with India, the country is also exploring ways to boost palm oil shipments to central Asia, Africa and the Middle East.

Malaysia's shipments to Pakistan surged more than 80 per cent from a month earlier to 74,000 tonnes during the first 20 days of January, according to cargo surveyor SGS Malaysia Sdn. Exports to India slumped almost 49 per cent to 30,500 tonnes, figures showed.

Meanwhile, rival Indonesia is cheering, as it expects higher purchases by India.

Indonesia has enough supply to fulfil India's demand, and the country is hoping to regain its export share in the south Asian nation that was lost after China overtook India in becoming Indonesia's biggest buyer, said Mr Mukti Sardjono, executive director of the Indonesian Palm Oil Association.

"Indonesia is bound to benefit from this but it's negative for palm oil as a whole," said Mr Gnanasekar Thiagarajan, head of trading and hedging strategies at Kaleesuwari Intercontinental. "Demand will be hit badly."