How will India’s economy be impacted if the conflict in West Asia continues. The conflict has already entered the third day after the US and Israel launched a coordinated military offensive against Iran on February 28. The focus is on oil price volatility, which could further push up inflation and hurt India’s trade balance and also the rupee. But can a regime change in Iran actually be good news for India’s economy?
What can be the game changer for India?
The Strait of Hormuz and the Middle East no doubt play an important part in India’s energy security. India imports more than 85% of its domestic oil needs. In FY25, Iraq, Saudi Arabia, UAE and Kuwait (in the Persian Gulf) cumulatively comprised close to 46% of India’s annual crude oil imports. Additionally, pressure from the US has led to a sharp drop in India’s crude oil shipments from Russia, versus a 35% share in FY25. That said, Nomura believes that “a regime change in Iran could lead to a dismantling of its sanctions, and India could benefit from the increase in global supply of crude oil as a consequence over time.”
India and the inflation risk: Oil companies have buffer to absorb price shocks
In theory, higher crude oil prices should lead to higher retail prices of fuel products and increased inflation. The RBI estimates that a 10% increase in global crude oil prices leads to a 0.15 pp drop in GDP growth and 0.3 pp increase in inflation, but this is based on the old inflation series, while the new one has doubled the combined weightings of petrol and diesel (to 4.8% from 2.3%), which should also raise the sensitivity of CPI inflation to oil price changes, if fully passed.
That said, Sonal Varma, Chief Economist for Nomura Holdings pointed out that “retail prices of petrol and diesel are unofficially pegged, with oil marketing companies (OMCs) absorbing the impact through their balance sheets. Therefore, we see a much lower impact of 0.1pp on inflation and GDP growth.” According to Nomura estimates, the marketing margins of OMCs are currently at Rs 10/litre for petrol and Rs 4/litre for diesel, which suggests there is a buffer to absorb the crude oil price shocks before the government needs to consider a fiscal hit to make up for under-recoveries.
Can higher crude impact India’s current account deficit?
The other big factor to monitor is how crude prices can impact India’s current account deficit.
Sonal Varma of Nomura pointed out that on the external front, “India’s current account deficit (CAD) is currently well balanced, and by our estimate should average 0.9% of GDP in FY26 and 0.8% of GDP in FY27, which is low by historical standards. This assumes global crude oil prices average $65/bbl over the year, and every 10% increase in crude oil prices typically widens the CAD by 0.4% of GDP.”
Rupee may face near-term pressure
Nomura however raised concerns about the rupee. Varma highlighted that, “India’s major external sector risk, though, is not from its current account but from the capital account, where a sharp drop in foreign investment flows is leading to a large balance of payments deficit in FY26. A combination of a widening CAD and FII outflows due to global risk aversion could accentuate rupee weakness.”
JM Financial also said that rupee may face near-term depreciation pressure, which may prompt intervention by the Reserve Bank of India.
Gaura Sengupta, Chief Economist of IDFC First Bank, however, believes that the escalation in geopolitical risks is expected to be shortlived, “There are risk-off sentiments in the near term with Dollar and Rupee crossing 91 in offshore markets.”
Every $1 rise in crude may add $2 billion to India’s import bill: JM Financial
Inflation is expected to shoot up if the conflict escalates further. JM Financial estimates that every $1 increase in oil prices will raise India’s annual import bill by around $2 billion.
“Higher crude increases inflation risk; higher inflation pushes bond yields up; rising yields compress equity multiples,” JM Financial noted. The report added that prolonged tensions could also raise marine insurance and logistics costs.
Conclusion
Higher oil prices create both direct and indirect fiscal pressures for the economy. Governments typically use fiscal policy as a wedge – through subsidies, tax cuts or excise duty reductions – to shield consumers from energy price increases. For now it is important to monitor the crude price action over the next few days.