The ongoing conflict in West Asia has intensified, with Iran asserting control over the Strait of Hormuz—one of the world’s most critical energy chokepoints, through which nearly one-fifth of global crude oil trade flows. By leveraging its strategic geographic advantage, Iran has disrupted maritime access, contributing to a sharp escalation in oil prices. Crude prices have nearly doubled over the past month, posing significant risks to global growth prospects for 2026-27. Meanwhile, the United States administration has responded inconsistently, reflecting the complexity of navigating a geopolitical situation in which it is itself deeply entangled.
India’s macroeconomic framework in recent years has been anchored in high growth, moderate inflation, and a gradual reduction in fiscal and current account deficits. However, the sudden surge in crude oil prices threatens to unsettle this balance. Reluctance on the part of the government to fully pass on higher fuel costs to consumers could strain public finances, while a widening trade deficit, combined with weakening capital and financial inflows, raises the possibility of a third consecutive year of balance-of-payments stress. Under these conditions, the Indian rupee, already under speculative pressure, is likely to remain under strain in the near term.
That said, there are mitigating factors. The risks from imported inflation appear less severe than in the past. Although wholesale price inflation in India has historically responded quickly to global commodity price shocks, the economy today is more resilient than it was a decade ago. Structural improvements and the experience of navigating successive disruptions, including the COVID-19 pandemic, the Ukraine conflict, and the US Trade Tariff, etc., have strengthened economic fundamentals. The government has, at times, used periods of crisis to push structural reforms, as seen in efforts to rationalize the Goods and Services Tax (GST) framework to support domestic consumption when access to US markets turned costly.
Importantly, India’s dependence on oil has been gradually declining in relative terms. Over the past two decades, the economy has expanded roughly fourfold, while crude oil imports have increased by only about 150 percent. This divergence reflects ongoing gains in energy efficiency and the steady expansion of renewable energy capacity, both of which are reducing vulnerability to external energy shocks. Consequently, investors should avoid applying overly pessimistic assumptions typically associated with other emerging markets to India’s outlook.
Financial markets, in fact, may have turned excessively pessimistic. The extent of currency depreciation and market volatility appears disproportionate when assessed against India’s underlying economic strength. As one of the fastest-growing major economies globally, India continues to exhibit a durable growth trajectory, with approximately 7 percent growth increasingly becoming the norm. Short-term disruptions should not be extrapolated into long-term structural concerns.
In the current environment, the most constructive role for monetary policy is to minimise uncertainty. Rather than focusing narrowly on repo rate adjustments, policymakers should address the dislocations evident in bond and credit markets. Corporate bond yields remain elevated, government security yields are still above 7 percent, and bank lending rates have not declined meaningfully, as banks continue to benchmark loans against relatively high alternative funding costs.
At the core of the bond market stress lies a structural imbalance between supply and demand. In recent years, the government has increasingly issued longer-duration securities. While traditional institutional investors, such as insurance companies, pension funds, and provident funds, prefer long-tenor instruments, their capacity to absorb additional supply may be nearing saturation. Furthermore, anticipated foreign inflows into Indian debt markets have fallen short of expectations.
Open market operations remain an important tool for the Reserve Bank of India to manage liquidity and stabilise yields. However, a more durable resolution will depend on a revival in organic demand for bonds. This, in turn, requires stronger deposit growth and improved balance sheet capacity within the banking system. Over the past year, banks have prioritised credit expansion over investment in government securities, exacerbating yield pressures in the bond market.
Looking ahead, these pressures may begin to ease by mid-year. Government borrowing is typically front-loaded in the first half of the fiscal year, and as liquidity conditions improve and demand recovers, bond yields could gradually moderate. While a sustained decline below 7 percent remains uncertain, the most acute phase of market stress is unlikely to persist indefinitely.
Finally, it is important to recognise that excessively low inflation can be as problematic as high inflation. A moderate inflation environment supports nominal growth, enhances corporate revenue generation, and fosters healthier credit expansion. Policymakers should therefore prioritise creating conditions that simultaneously support growth, revenue stability, and market confidence.
