Two months into the U.S.-Iran war, India is experiencing a classic external supply shock that is depressing growth and elevating inflation.
India enters FY27 with exceptional structural economic advantages: 7.6% growth in its economy, reduced U.S. tariffs, a strong services export base of $418 billion, and healthy foreign exchange reserves sufficient to cover 11 months of imports.
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But the oil shock has reached a point that has historically overwhelmed emerging market economies.
We outline what to expect in the next 90 days:
First, inflation is the primary macro risk, not growth. We expect India’s consumer price index for April to exceed 4%. If the May CPI continues to increase toward 4.5% or 5%, India’s central bank will have to decide whether a rate hike is needed to restrain inflation.
We assign a 30% probability to a 25 basis-point hike at the June meeting of the central bank’s Monetary Policy Committee, and a 70% chance that it will hold its policy rate steady with hawkish language. A rate hike in this environment, while painful for growth, would be the right call: It would defend the rupee, anchor expectations and signal institutional credibility.
Second, the rupee is not in crisis, but it is structurally weak. The exchange rate on Monday was at a historically low 95.35 rupees per dollar. In addition, India’s economy is facing a collapsing foreign direct investment inflow, structural foreign portfolio investment outflows, and an import bill rising faster than export earnings.
The Reserve Bank of India should not use reserves at the rate seen in February and March to defend an unsustainable level. We think 93 to 96 rupees per dollar is the new realistic trading range.
A return to 90 requires either a sustained decline in the price of oil or a reversal of foreign portfolio investment outflows, neither of which appears imminent.
Third, the government’s fiscal position is more stressed than the headline deficit suggests. The excise duty cut, the additional subsidy burden and elevated borrowing all point to upward pressure on the fiscal deficit.
If Brent crude, the global benchmark, stays above $100 a barrel, we estimate the fiscal deficit could drift from 40 to 60 basis points above the 4.3% of GDP target without corrective action.
The government has limited room to respond as its political economy after the West Bengal elections and the ongoing conflict constrain bold fiscal consolidation.
Fourth, India’s medium-term growth story remains intact. The structural drivers of India’s economy—demographics, the digital economy, manufacturing and infrastructure investment, are real.
The U.S. tariff reduction from 50% to 18% is a genuine earnings tailwind for Indian exporters worth 0.3% to 0.5% of GDP per year. The coal gasification scheme, if executed, will reduce India’s structural energy vulnerability starting in 2029.
The private consumption acceleration to 7.7% growth reflects a genuine improvement in household balance sheets and credit availability.
We expect 6.5% to 6.8% growth next fiscal year under our base case—below the Reserve Bank of India’s forecast of 6.9% and above the International Monetary Fund’s 6.5%—with the band widening materially depending on how long the war lasts. The downside scenario (prolonged war, Brent crude above $110 through the third quarter) puts growth next fiscal year at 5.8% to 6.2%.
The takeaway
India has strong fundamentals: 7.6% growth last year, a large services export base and adequate foreign exchange reserves. The problem is that a sustained oil shock puts pressure on all three variables that matter most right now: inflation, the rupee and the fiscal deficit.
The Reserve Bank of India will most likely hold rates steady in June, but if inflation continues to rise as oil prices remain elevated, a hike becomes hard to avoid.
The rupee has no obvious near-term support, FDI is falling, FPI outflows are persistent, and the import bill is rising. On growth, 6.5% to 6.8% for the next fiscal year is still a reasonable estimate, but the range of outcomes is wide and depends almost entirely on how long the conflict runs.
