India's economy, once thriving with steady growth and benign inflation, is now facing a mounting cost due to the Iran war. As the world's third-largest oil importer and consumer, India's economy is highly exposed to the war's disruptions, particularly the blockade of the Strait of Hormuz, which affects a fifth of global oil and gas transit. This has led to a 53% jump in India's oil-and-gas import bill in April, prompting concerns about the balance of payments (BoP) deficit. Economists predict that the impact on economic growth, inflation, and government finances will intensify as long as oil prices remain elevated.
Michael Langham, an emerging markets economist, warns of a series of supply shocks for India. The country faces not only pressure on oil prices but also supply disruptions to fertilizers, which will impact key crops like wheat, especially with the looming threat of an El Niño weather phenomenon. The Reserve Bank of India (RBI) has taken measures to contain the impact on the rupee and foreign exchange reserves, but analysts doubt their effectiveness in the face of overlapping supply shocks.
The Iran war has disrupted India's central bank governor, Sanjay Malhotra's, optimistic outlook for the economy. Inflation levels were falling and growth remained strong, but the war has led to a surge in oil prices, causing a 30% increase in overall oil prices and a 75% rise in gas prices. As a result, the RBI now predicts an average inflation rate of 5.1% in the financial year ending March 2027, up from 3.48% in April, and economic growth slipping to 6.6% from 7.7% in the previous year.
The RBI has kept interest rates on hold, but markets anticipate rate hikes of 25 basis points over the next three months and more than 75 basis points over the next year. Sat Duhra, a portfolio manager, highlights India's deeper structural challenges, including the impact on foreign direct investment, employment, manufacturing expansion, consumption, and nominal GDP growth. The energy shock will further undermine growth and pressure government finances, making it difficult for policymakers to make decisions.
India's delay in raising retail fuel prices has kept petrol and diesel prices relatively stable, up less than 10% compared to 50% or more in other oil-importing countries. The government's strategy of not compensating fuel retailers for losses may reduce its financial firepower to handle the crisis. The government's fertiliser subsidy is expected to increase by 20% in 2026-27, and the government has also cut gasoline and gasoil taxes, forgoing 140 billion INR in monthly revenues.
The government's fiscal deficit target of 4.3% of GDP this financial year is under threat, with forecasts suggesting it could reach 4.7% or even 5%. India-based credit rating agency Crisil predicts further small price increases in retail oil prices, which will have a wider impact, affecting transport costs and pushing up food and core inflation. The broader effect will reverberate across the economy, making it a challenging situation for policymakers and the public.
In conclusion, the Iran war has significantly impacted India's economy, causing a series of supply shocks and disruptions. The country's ability to manage these challenges is crucial, and the government's decisions will have a profound effect on the nation's financial stability and growth.
