Morgan Stanley flags energy shock as key risk, warns current account deficit may widen to 3%

The Morgan Stanley report stated that the slowdown is largely a consequence of the ongoing Middle East conflict and its effects on global energy prices, not a sign of anything structurally wrong with India’s growth story. Domestic demand, they argue, remains the economy’s anchor.

The data is still holding up

April’s numbers came in stronger than most had expected. GST collections hit an all-time high. Manufacturing and services PMIs both moved higher. Bank credit growth stayed firm, and corporate earnings for the March quarter beat estimates on the back of healthy demand and stable margins, as per the Morgan Stanley report. 

The worry, though, is that the energy shock has not fully worked its way through yet. Coal prices are up 20-22% in recent weeks as industries switch away from gas. LPG consumption fell 13% year-on-year in April, the second consecutive monthly drop. Morgan Stanley expects these pressures to show up most visibly in the June quarter, when growth is forecast to trough at 6.5% before recovering gradually through the rest of FY2027.

Consumption trend patchy

Urban consumers are still spending. According to the report, retail auto sales are healthy, personal loan growth is running at 15.6%, and the jobs market is improving. The report further noted that energy shock is more likely to hit households through second-round inflation effects than directly through fuel costs.

Rural India is the softer patch. It had been outgrowing urban demand for eight straight quarters, helped by two good monsoon seasons and low food inflation. That run is now under threat. The IMD is forecasting a weaker monsoon this year due to El Niño conditions, and there are early concerns about fertiliser and seed availability going into the kharif season. The RBI’s rural consumer confidence index has already slipped into pessimistic territory on current conditions, as per the report. 

The government is spending, but private sector is cautious

The report also noted that the central government’s capital expenditure is expected to grow 11.5% year-on-year in FY27, with infrastructure spending up 14%. The Centre has also set aside Rs 2 trillion to push states to accelerate their own infrastructure outlays, the report said. 

Private capex is picking up but remains narrowly concentrated in sectors like power, semiconductors, data centres and electronics. According to the report, the cycle is at an inflection point, but says near-term momentum is more execution-driven than broad-based, which essentially means that it depends on specific large projects getting off the ground rather than a widespread upturn in business investment.

Inflation is set to rise

India goes into this period with inflation looking comfortable,  CPI was at 3.5% in April 2026. That is not expected to stay. According to Morgan Stanley, CPI is expected to average 4.7% for FY2027, pushed up by higher production costs, a weaker rupee, and knock-on effects on core inflation.

Because fuel has a relatively low weight in India’s consumer price basket, the direct hit from global oil prices is limited. But food inflation risks from a potentially weaker monsoon, combined with rising input costs filtering into goods prices, mean inflation is expected to average above 5% in the second half of FY2027. The bank forecasts core inflation at 4.5% for the full year.

The current account is widening

According to the report, India’s external position is comfortable for now as the current account deficit has averaged around 1% of GDP since the pandemic, and foreign exchange reserves remain substantial. But higher oil prices are expected to push the deficit to around 1.8% of GDP in FY27, assuming an average Brent of $87.5 a barrel, as per the report. 

If oil stays closer to $110 a barrel, Morgan Stanley noted that the deficit could widen to 3% of GDP.

Capital flows are also thin, as FII outflows totalled $13 billion in FY2026. As per the report, net FDI has been subdued. The balance of payments is expected to remain in deficit for a third consecutive year, something that has not happened before, putting more pressure on the RBI to defend the rupee through reserve drawdowns and non-rate measures rather than conventional monetary policy.

RBI to hold, then hike modestly

According to the report, the RBI is expected to keep rates on hold through FY27, leaning instead on tools like tighter overseas investment norms and steps to attract NRI deposits and foreign exchange inflows. The rate hiking cycle, when it arrives, is expected to be modest with two 25 basis point increases in the first half of FY2028, taking the policy rate to 5.75%.

On the fiscal side, the government is expected to overshoot its FY2027 deficit target of 4.3% of GDP by around 30-50 basis points, owing to higher subsidy costs on fuel and fertiliser and the likelihood of some revenue shortfall. As per the report, capital expenditure is to be protected regardless, with the government prioritising growth over fiscal consolidation.

What could go wrong

A deeper global slowdown, a prolonged conflict, tighter global financial conditions, or a bad outcome in India-US trade talks could all make the growth-inflation trade-off harder to manage. In a scenario where oil averages $110 a barrel through FY2027, GDP growth could come in at 6.2% rather than 6.7%, and the current account deficit could breach the level policymakers consider safe.

The upside scenario is straightforward: if commodity prices fall faster than expected, corporate margins improve, business confidence picks up, and private investment broadens beyond the handful of sectors currently driving it. That would give policymakers more room and could accelerate the capex cycle that India has been waiting on for years.

For now, Morgan Stanley’s view is that India will weather the current shock. But the buffers that have made that possible are getting thinner.