Policy challenge: Oil shocks and monsoon risks cloud India's outlook

Global economic uncertainties arising from geopolitical tensions are clearly reflected in the latest World Economic Outlook of the International Monetary Fund (IMF). The IMF in its projections, keenly followed across the world, has presented scenarios. Under the reference forecast, the world economy is expected to expand 3.1 per cent in 2026, slower than the 3.4 per cent in 2025. The global headline inflation rate is expected to increase to 4.4 per cent in 2026. The IMF notes that the growth projections would have been revised upwards in the absence of the war in West Asia. In the adverse scenario, which assumes persistently higher energy prices, global growth will decline to 2.5 per cent in 2026 and the inflation rate will increase to 5.4 per cent. Under the severe scenario, which assumes more damage to energy infrastructure, global growth could come down to just about 2 per cent, and the headline inflation rate will move above 6 per cent by 2027.

 

The brunt of the war and persistent geopolitical tensions could vary across countries, with economies dependent on imported energy likely to face a greater impact. For India, compared to the January update, the growth projection for the current year has been increased by 0.1 percentage point to 6.5 per cent. This takes into account the strong momentum from last financial year and the fact that tariffs imposed by the United States (US) on Indian goods have declined substantially. However, it must be noted that these projections could change rapidly, depending on the situation in West Asia. An early resolution will help keep outcomes close to the reference forecast. News reports suggest that both the US and Iran are willing to continue negotiating after the weekend talks in Islamabad failed to yield a deal. A lot will depend on the conditions in which the negotiations take place. This is important because, given the complexity of the situation and the stated positions of the two sides, arriving at a durable resolution could take time. Meanwhile, it would be important that the energy supply from the region is restored. The US Navy is blocking Iranian ports. Although America has said it will let ships from other countries pass, its action might affect the negotiations and the Iranian position. Meanwhile, Israel’s attacks on Lebanon continue, which could also have implications.

 

Given the rapidly evolving situation, it is difficult to say anything with certainty. This complicates decision-making for both policymakers and businesses in a country like India that relies heavily on energy imports, particularly from the region. Higher global energy prices are not yet reflected in the inflation numbers because of limited pass-through. The retail inflation rate for March was at 3.4 per cent as against 3.2 per cent in the previous month. This could change significantly as pump prices are adjusted. Higher prices of crude oil tend to reduce growth and increase the inflation rate. The current shock, if it persists, may have a bigger impact than what is normally assumed in higher oil-price scenarios. The availability of gas, for instance, is a problem that is affecting output, and it will eventually be reflected in prices. An added complication for India is the possibility of a below-normal monsoon. The India Meteorological Department has said the monsoon this year will be below normal at 92 per cent of the long-period average. An impact on agricultural production could also push up the food inflation rate. Thus, Indian policy managers need to be alert. To the extent possible, the government must focus on easing supply pressure. The Reserve Bank of India, meanwhile, needs to ensure that the possibility of higher fuel and food inflation rates doesn’t end up affecting inflation expectations.