The Indian economy, once a shining star of global growth, is now facing a series of challenges that are threatening to dim its luster. The Iran-Israel war, a conflict that has sent shockwaves through global markets, has had a particularly profound impact on India, a country heavily reliant on oil imports and with a large agrarian sector. The mounting costs of this war are becoming increasingly apparent, and the Indian government and central bank are struggling to contain the fallout.
One of the most immediate consequences is the surge in oil prices. India, the world's third-largest oil importer, has seen its oil-and-gas import bill jump by 53% in April alone. This has led to a ballooning balance of payments (BoP) deficit, which is essentially the money coming into the economy minus the money going out. The Indian government and central bank have announced a flurry of measures to contain the impact on the rupee and foreign exchange reserves, but analysts say the broader drag on economic growth, inflation, and government finances is set to increase as long as oil prices remain elevated.
The situation is made more challenging by the fact that India is also facing supply disruptions to fertilizers as a result of the Iran war. This will impact key crops like wheat, at a time when farmers are already bracing for an El Niño weather phenomenon that often portends drought. The government's fertiliser subsidy is likely to jump by 20% in 2026-27, and the government is also cutting gasoline and gasoil taxes, forgoing 140 billion INR in monthly revenues. These measures are necessary to support the agrarian economy, which supports nearly half the population, but they come at a cost for the government, such as through reduced dividends and a weaker fiscal position.
The Indian government is also targeting a fiscal deficit of 4.3% of GDP this financial year, but a Reuters poll forecasts it could swell to 4.7%, and some economists see it going as high as 5%. This is a significant challenge for the government, as it will need to find ways to rein in public-sector capital expenditure (capex) to stabilize conditions, while also supporting the economy through measures like delaying retail fuel price hikes and cutting taxes. The government's strategy of not compensating fuel retailers for losses is likely to come at a cost for the government, such as through reduced dividends and a weaker fiscal position.
The central bank, meanwhile, sees inflation averaging 5.1% in the financial year to the end of March 2027, up from a 3.48% reading in April, and economic growth slipping to 6.6% from 7.7% in the previous year. The RBI has kept rates on hold for now, but interest rate swap markets are pricing in at least 25 basis points of rate hikes over the next three months and more than 75 basis points over the next year. This is a difficult position for the central bank, as it will need to balance the need to control inflation with the risk of further slowing growth.
In my opinion, the Indian economy is facing a series of supply shocks that are threatening to undermine its growth outlook. The ability of the RBI to look through the energy price shock from the Strait of Hormuz will be increasingly difficult given the overlapping nature of these supply shocks. The Indian government, meanwhile, is in a difficult position, as it will need to find ways to rein in public-sector capex to stabilize conditions, while also supporting the economy through measures like delaying retail fuel price hikes and cutting taxes. The broader effect of these challenges will reverberate across the economy, pushing up transport costs and core inflation, and putting further pressure on the government and central bank to find solutions.
One thing that immediately stands out is the impact of the Iran war on India's economy. The war has led to a surge in oil prices, which has had a profound impact on India's balance of payments and fiscal position. The Indian government and central bank are struggling to contain the fallout, and the broader effect of these challenges will reverberate across the economy. This raises a deeper question: how can India's economy be made more resilient to external shocks, and what steps can be taken to mitigate the impact of future conflicts on the country's economic stability?
