The ongoing conflict in West Asia will undoubtedly deliver a major shock to the Indian economy. This is due not only to India’s huge dependence on imported oil and gas, but also to the country’s fiscal constraints and its vulnerability on the balance of payments front.
As many economists and media reports have pointed out, the supply shock is already becoming visible in different segments of the Indian economy. The price shock has been contained somewhat by the government’s decision to take a hit on its own finances by reducing the special additional excise duty on petrol and diesel. This response is understandable because the conflict situation is highly unpredictable, and the government has contained the price impact on the economy through what seems to be a temporary measure. That several states in the country were going into Assembly elections also influenced this decision.
But even if there is an early agreement on a cessation of hostilities in West Asia, the price shock will not go away easily. Global prices of crude oil and gas will remain elevated, higher than what India was used to over the last few years. This will have an all-round effect on the Indian economy, even as the government considers allowing a gradual increase in retail prices for petroleum products after the Assembly elections conclude next week.
How serious will that price shock be for the Indian economy? Finance Minister Nirmala Sitharaman has assured the nation by indicating that the Union government has the fiscal space to address some of these concerns. Will that be enough?
Before Covid dealt its shock, the Union government’s fiscal deficit was 4.6 per cent of gross domestic product (GDP) in 2019-20. A year later, that figure shot up to 9.2 per cent. Thanks to the government’s deft management of its finances, a big push to its capital expenditure and a smart recovery in tax collections, the fiscal deficit declined swiftly to 6.7 per cent in 2021-22 and finally settled at 4.4 per cent in 2025-26.
Given the West Asian impact, the Union government’s fiscal policy strategy will have to be revised appropriately. The Budget in February 2025 indicated a debt glide path, with the medium-term aim of reducing the debt from 55.6 per cent of GDP in 2026-27 to 50 per cent (within a range of 1 percentage point either way) by 2030-31. A fiscal deficit of 4.3 per cent for the current year was set as the operational target, linked to the prevailing debt level. Both the debt and deficit levels will require appropriate adjustment. The government would do well to prepare a medium-term strategy on the revised targets so that the markets have a better sense of the path ahead. More importantly, such a message will be an important signal for the Reserve Bank of India and its Monetary Policy Committee that will guide monetary policy in the coming months.
A key component of the Union government’s expenditure will also need appropriate revision. Major subsidies account for over 10 per cent of the Union government’s total revenue expenditure. With fertiliser prices spurting, there is no way its fertiliser subsidies bill will be contained at ~1.71 trillion in the current financial year. The government’s revenue expenditure will also feel the impact of higher provisions for some announced schemes and a few more that may be needed. On receipts, tax collections will be adversely impacted and the revenue from monetisation of assets may not materialise as envisaged in the Budget.
So far, various think tanks, research bodies and multilateral institutions have indicated a marginal slowdown in growth during 2026-27. At around 6.5 per cent, as projected by these organisations, the annual growth rate in the current year would be lower than the 7.6 per cent estimated for 2025-26. But if economic activities get adversely impacted during the year (already some dislocation, particularly in the micro, small and medium enterprises sector, has been noticed), the annual growth rate will be lower than what is being projected now. This will also have an adverse impact on government revenues and the performance of companies in the organised sector.
Adding to the woes will be the monsoons. The latest forecast for the current year indicates below-normal performance due to the dreaded El Nino effect on the weather system. However, the impact of a poor monsoon on India’s agriculture is now much less than it used to be. Nevertheless, poor rainfall has second-order effects on the rural economy, which, in turn, will have an impact on the overall economic activity and the government’s revenue collections.
India’s external sector also poses a challenge. India’s current account deficit looks comfortable at around 1 per cent of GDP in the first three quarters of 2025-26, when compared to the deficit levels of over 4 per cent in 2011-12 or 2012-13. But the current account deficit is now accompanied by net foreign investment flows that have turned negative. Reflecting this trend has been the net foreign direct investment flows, which also declined last year. With prolonged uncertainties in West Asia, India’s remittance flows may also be adversely affected.
Clearly, the managers of India’s economy have their tasks cut out. In recent weeks, however, the government has been preoccupied with the ongoing Assembly elections. Even a special session of Parliament was held to consider advancing the delimitation of constituencies and the reservation of women in the Lok Sabha and Legislative Assemblies.
India’s economic challenges right now may not be severe enough to call for a special session of Parliament. But there is no reason why the government should not start preparing the nation for the hard steps that need to be taken to manage the economic challenges ahead. More importantly, it should review its macroeconomic assumptions for the next few years and set more achievable targets.
AK Bhattacharya is the Editorial Director, Business Standard. He tweets @AshokAkaybee. Views are personal.