India’s Goldilocks moment is over, macro situation will worsen

The fiscal burden of the West Asia crisis on the Centre could be around 0.5 per cent of GDP. The uncertain environment will also make it difficult for the Centre to meet its disinvestment target

The Indian economy was in a so-called Goldilocks situation until a few months ago. GDP growth was estimated at a healthy 7.6 per cent in 2025-26, inflation was benign, averaging around 2 per cent, the current account deficit was estimated at roughly 1 per cent of GDP and the Centre was following fiscal consolidation. The West Asia crisis and the subsequent sharp rise in energy prices and disruption in energy supply chains has flipped the situation for the Indian economy. Given India’s high energy import dependence, the economy will be impacted through multiple channels including growth, inflation, the balance of payments and government finances.

While there is no clear signal around resolution of the crisis, the supply damage and lingering uncertainty are likely to keep global crude oil prices high at around $85-90/bbl in 2026-27. With high prices and disruption of the global energy supply chain, we expect India’s GDP growth to slip to around 6.7 per cent this year, compared to our pre-conflict projection of 7.2 per cent. Unfortunately, there are also chances of El Niño, and a weaker monsoon could also hurt the domestic demand outlook.

Even while crude oil prices have risen by 40 per cent since the beginning of the conflict, households have been shielded from any rise in the retail prices of petrol and diesel. The government has cut the excise duty on petrol and diesel to cushion the impact of higher crude prices. However, with global prices likely to remain elevated, there will be some pass-through to the consumers. There will also be a second-round impact on inflation through higher raw material prices for many industries. CPI inflation is likely to average 4.6 per cent this year as against our pre-conflict projection of 4.3 per cent. And if there is a poor monsoon season, there will be upward pressure on food prices.

The hit on GDP growth may not be very grave as the economy continues to benefit from lower interest rates, cuts in GST, a broad momentum in domestic demand and healthy services export. The inflationary impact will also be relatively subdued as the burden of high global oil prices is likely to be shared between the government, oil marketing companies and households.

However, there are serious concerns around India’s balance of payments, which is going to be hit hard by a widening current account deficit and dwindling capital flows. With India importing 88 per cent of its oil requirement (51 per cent of it from West Asia), and the share of goods exports to West Asia being 15 per cent and remittances from the region 38 per cent of the total, this crisis will have severe repercussions for India’s current account balance. We expect India’s current account deficit to widen to 2.1 per cent of GDP in 2026-27, as against our pre-conflict projection of around 1 per cent.

As far as capital flows are concerned, there were steep FPI outflows of $14 billion in March, taking total outflows in 2025-26 to $17 billion. In previous stress periods such as the global financial crisis, the taper tantrum, the pandemic, and the Russia–Ukraine conflict, pressure on the capital account was largely characterised by sharp FPI outflows, while FDI inflows remained comparatively resilient.

Unfortunately, this time, net FDI flows are also very weak. India’s net FDI flows (gross investment less repatriation and outwards FDI) were at just $1.7 billion in April-January 2025-26, following a subdued inflow of $1 billion in 2024-25. While gross FDI inflows have been healthy, a sharp rise in repatriation of profits by foreign investors and high outward FDI by Indian investors have resulted in muted net FDI flows. Other components of the capital account like external commercial borrowing have also been weak. This has resulted in the total capital account balance in the first three quarters of 2025-26 being close to zero, and is likely to take India’s balance of payments into negative territory. This will have implications for the Indian currency, which has already weakened sharply over the past year. India has large forex reserves of around $700 billion. However, adjusting for gold holdings and SDRs, it falls to about $570 billion, and further adjusting for the RBI’s forward position, the number falls to just below $500 billion. So far, it is still comfortable, providing more than eight months of import cover.

The West Asia crisis will also result in increased fiscal burden. The cut in excise duty on petrol and diesel will result in a revenue loss for the Centre. Moreover, there will be upward pressure on the fertiliser subsidy given the sharp rise in LNG prices. In fact, there could also be some pressure on the government’s other tax revenues, as the growth momentum slows. Overall, we feel that the fiscal burden of the West Asia crisis on the Centre could be around 0.5 per cent of GDP. The uncertain environment will also make it difficult for the Centre to meet its disinvestment target. All this could disturb its fiscal consolidation path. State governments’ finances were already under pressure with rising expenditure towards election-related doles and cash transfers; the crisis could put further strain on their finances. As the Centre and states struggle to meet their deficit targets, capital expenditure could come under pressure.

The West Asia crisis has hit India at a time when the country was relatively better placed in terms of macro fundamentals. The government and central bank have announced some measures to shield the economy in the short run. But, for the medium to long term, this crisis has highlighted the urgent need for India to strengthen its energy security. The events of the last few years have emphasised the need to build broader resilience to all kinds of global supply disruptions. India also needs to ensure that capital flows are stable. This requires making the country an attractive investment destination.

The writer is chief economist, CareEdge Ratings