Rising energy costs and the trade shock from the Iran War are expected to put pressure on India’s GDP growth and fiscal deficit in FY27. According to an Emkay report, India’s real GDP growth is estimated to decline by 0.4 percentage points in FY26, dropping to 6.6 per cent.
Further, the Emkay report stated that headline inflation is estimated to increase by 0.3 percentage points in the fiscal year 2026-27, reaching 4.3 per cent. Additionally, the current account deficit (CAD) is also expected to widen to 1.7 per cent of GDP, an increase of 0.4 percentage points.
Who would bear oil cost?
The Emkay report states that the eventual effects on GDP growth rate, inflation, and the fiscal deficit will largely depend on how international crude price increases are distributed among oil marketing companies, the government treasury, and consumers.
The report shows that in order for oil marketing companies to achieve normalized gross marketing margins at current Brent crude prices, retail prices of diesel and petrol need to be increased by 43 per cent and 19 per cent, respectively.
On the other hand, if the government decides not to pass the increased cost burden to consumers and fully absorbs the losses of oil marketing companies, it would result in a fiscal cost of nearly 1.1% of GDP. To achieve this, the government will need to cut excise taxes on diesel and petrol by about Rs 19.5 per liter and absorb the additional subsidy of about Rs 11 lakh crore on LPG.
Unique challenges before RBI
Emkay report stated that the Reserve Bank of India’s policy response to the ongoing energy price shock is likely to be challenging due to multiple trade-offs involving inflation, growth, liquidity, and currency stability.
The report highlighted that there is no straightforward policy approach to address an energy-driven shock, especially when inflation remains relatively benign, but risks are rising due to second-round effects.
The report noted that before the conflict, the RBI’s focus was on improving monetary policy transmission, particularly in the bond market, supported by ample liquidity that kept overnight rates below the policy rate.
However, the current situation has become more complex as rising oil prices are now influencing inflation expectations, growth outlook, and financial conditions. The report said the central bank faces a difficult choice between supporting growth and controlling inflation while managing currency pressures.
The bar for a conventional rate hike remains high, given that the shock is supply-driven, but the RBI may also need to reassess its liquidity stance.