This appeared in the Times of India on 14 May 2026 (link).
Well into the third month of the Iran war, earlier assumptions of a short-lived conflict have now been well and truly negated. Over the past week, even as physical shortages of oil seem to have eased, the price of oil for March 2027 delivery has risen nearly 10% to US$83/barrel. It is now prudent to start measuring the impact on the economy, and for policy to begin adjusting.
To estimate growth rates going forward, it is important to assess where we were before the war.
Back in 2024-25, the economy grew at 7.1% in real terms despite significant and simultaneous fiscal and monetary tightening. This implies that underlying economic momentum was much stronger than 7.1%. Monetary headwinds continued till the first half of last year, when easing monetary conditions, and GST cuts, boosted economic momentum. This year, with nearly no fiscal tightening, and monetary tailwinds, pre-war real growth was expected to be 7.5%. Indicators in March and April showed growth was better than expected despite the war dominating headlines, with strong growth in autos, cement, credit, and consumer goods.
Let us now measure the impact of the energy price shock. Major forms of dense energy imported by India are crude oil, natural gas, fertilizers and edible oil. Making some assumptions to simplify the sensitivity analysis, we find that if oil prices stay US$15 per barrel over last year’s average of US$70 for a year, the impact would be US$40bn, or 1% of GDP. At last few weeks’ average of around US$100/bbl, the headwinds are at the pace of 2% of GDP.
This ‘terms of trade’ shock – the need to pay US$80bn more for energy meaning there is less to buy locally produced goods and services – will be split between a rise in fiscal deficit and economic growth.
The cut in excise duty on petrol and diesel, continuing losses at oil marketing companies (OMCs), and subsidies on LPG and fertilizer together account for additional monthly subsidy of around forty to forty-five thousand crores. This has defrayed 1.2% of GDP of impact so far.
The remaining 0.8% of GDP has flowed through market channels – prices of plastics and chemicals, for example, are up sharply, curtailing demand. Whereas the sharp increase in plastic prices has effectively shut down plastic furniture manufacturing (unclear when plastic prices may fall again, they do not want to be stuck with high-cost inventory), plastic use for packaging is relatively unaffected so far (usually a small part of the end-product cost, and so can be passed on or even absorbed).
The government’s economic stabilization fund of Rs1 trillion should last for 2.5 months at the current pace. If oil prices remain elevated, they will need to start raising fuel prices at the pump and LPG prices. A Rs10 per litre increase for diesel and petrol would be a 0.4pp of GDP annually – this would reduce the fiscal deficit run-rate and bring down growth.
A much more important constraint is the availability of dollars. While the RBI’s foreign currency reserves can meet a temporary problem in Balance-of-Payments (demand vs. supply of dollars), recent trends indicate panic has set in, with dollar shortages being much worse than what fundamentals would suggest.
Whereas the full year dollar shortage in the last fiscal year should have been in the range of around 25 billion dollars. But the RBI had to intervene by over 80 billion dollars just in the last six months of the year. This means exporters have slowed hedging (reducing supply of dollars), and importers and foreign investors are hedging much more than they used to (raising demand for dollars).
Increase in import duties on gold and silver is designed to reduce ‘non-essential’ imports, but may not suffice. Higher retail prices of petrol and diesel can help, by reducing demand and the import burden.
Will there be physical shortages of oil and related products? Other than natural gas (a relatively small part of India’s energy supply) and LPG (volumes down 16-17% versus last year in March and April), for now significant shortages appear unlikely, in our view.
India has a refining surplus, and given that refining margins are up sharply too, as the blockage of the Strait has affected not just crude oil supply but also refining capacity, Indian refiners are able to source crude and sell the product locally.
In fertilizers, the farmers most impacted will be from countries that do not subsidize (like the US, given that the urea-to-corn-price ratio is at a record high) or cannot subsidize (like Sri Lanka or Pakistan).
The remarkable stability in oil prices in April was despite and likely due to China drawing on 3.5 million barrels per day of inventory, more than 3% of global demand, and 10% of its strategic reserves. This kept global markets stable, and the warring sides felt no pressure to compromise for an agreement.
However, even strategic inventories cannot last forever. Stocks of aviation fuel (ATF) at the key ARA hub in Europe, for example, are down by a third in two months, and major European airlines have had to cut flights in May to optimise. Global airline seat kilometres were down 2.5% year-on-year in April, versus a pre-war growth of 5%, but may fall further, just when the northern holiday season starts.
Even as markets and therefore the combatants wait for the markets to panic, the government’s approach may need to change to adapt to a longer period of elevated energy prices, which includes letting the economy adjust to new energy market realities.