The crisis in West Asia has become a prolonged geopolitical risk, casting a long shadow over global markets and the Indian economy. Although the impact remains limited in the near term, it is likely to become more prominent in the coming quarters. Globally, consumer price index (CPI)- based retail inflation inched upward across major economies such as the US, China, and the Euro Area, due to cost-push pressures from surging global energy prices. As investors rule out further quantitative easing amid rising inflation, government bond yields have hardened, with the 10-year US bond yield hovering around 4.5%.
After marking a year with stable and low inflation, the Indian economy enters the next fiscal with challenges of an unfavourable base effect and imported energy inflation. Further adding to consumer fears is the India Meteorological Department’s (IMD) recent projection of below-normal monsoons in 2026, with a downward revision in rainfall estimates from 92% of the Long Period Average (LPA) to 90% due to the developing El Niño in the Central and East Pacific Ocean. A potential spike in food prices, as evidenced by the rise in consumer food price inflation to 4.2% in April 2026 from 3.48% in March 2026, can adversely affect domestic demand. On the monetary policy front, upside risks to inflation in the coming months have likely eliminated the room for monetary easing.
With the advent of the new Index of Industrial Production (IIP) series with a base of 2022-23, this year marks another milestone in the rapid overhaul of economic data reporting following the base revisions of the CPI and Gross Domestic Product (GDP) series. The revised IIP series reveals that industrial activity was more robust in the first half of FY 2025-26 than in the earlier print, but in the latter half it contracted for most months. IIP grew at 4.9% in April 2026, higher than 3.2% in March 2026, but lower than 5.3% in February 2026. Going forward, IIP numbers are expected to fluctuate in the case of a prolonged West Asian conflict, which may have adverse spillover effects on economic growth.
On the fiscal front, the Union government successfully contained its fiscal deficit for FY 2025-26 at 4.4% of GDP, as revealed by data from the Controller General of Accounts (CGA). However, slight upside risks to the fiscal outlook for FY 2026-27 remain due to recent external volatility. Possibly, government finances will have to bear the brunt of escalating fertilizer prices, which translate into subsidy expenditure and absorption of rising fuel prices through cuts in excise duty. This can also be seen in the gulf between CPI and wholesale price index (WPI) numbers for April 2026, as the government tries to shield consumers from skyrocketing energy prices. Nevertheless, RBI’s record surplus of Rs. 2.86 lakh crore, marking a 7% annual increase from last year, coupled with strong goods and services tax (GST) collections, will provide some cushion for the fiscal deficit in the current fiscal.
With the government’s ambitious borrowing programme, fears of rising inflation, and external turbulences, the yield on benchmark 10-year securities remain sticky at above 7%. Moreover, the credit to deposit ratio remains above 82%, tightening bank liquidity, thus making borrowing expensive. Nonetheless, market participants will be closely watching the impact of the Reserve Bank of India’s (RBI) intervention to inject durable liquidity through a USD 5 billion USD-INR buy-sell swap conducted at the end of May.
On the external front, a multitude of factors have turned investor sentiment negative toward India, resulting in net foreign institutional investor (FII) outflows, as India remains a net energy importer. The rupee’s spot exchange rate reached a high of 96.97 against the US Dollar in May 2026. Despite the government’s concerted efforts to ramp up domestic energy production and protect households from energy price pressures, the overall sentiment remains pessimistic. However, the RBI Governor’s recent statement that the rupee might be undervalued in both nominal and real effective exchange rate terms provide reassurance of India’s underlying economic strength.
The Indian economy’s resilience will be tested in a world marked by rising unpredictability. The extraordinary strength exhibited by the economy in the last fiscal year, as the fastest-growing major economy, faces new challenges amid an uncertain global order. Moving forward, this remarkable past performance, backed by sound macroeconomic fundamentals, must now be replicated.
