India's misunderstood shock: Lessons from the pandemic on what not to do

India is facing yet another shock. If there’s a silver lining in a world where disruptions arrive with the regularity of monsoon forecasts, it’s that we get better at choosing which policy responses help — and which ones don’t.

 

With the Reserve Bank of India’s first policy meeting since the ongoing energy shock underway, the obvious question is whether rate hikes are coming. After the central bank’s recent moves to curb currency arbitrage by limiting banks’ positions and cutting off offshore routes to stabilise the currency, attention has turned to whether an interest-rate defence will be used to support the rupee. Simply put, will the central bank hike rates?

 

Our view is that the bar for rate hikes is not that low.

 

This isn’t your simple oil price shock. The temptation is to compare today with 2022, when Brent averaged around $100/barrel. Brent has crossed that level again, and India’s oil import basket contains sources that have risen even more than Brent. So, case closed?

 

Not quite. The current episode looks different in two important ways.

 

First, it’s not just oil. It’s broader and more severe, with disruptions in natural gas and liquefied petroleum gas (LPG) compounding the impact and cascading into downstream sectors — petrochemicals, fertilisers, power, and manufacturing. When energy inputs get messy, the spillovers don’t stay neatly contained.

 

Second, unlike past episodes that were largely price shocks, this one also involves hard quantity constraints. Capacity has been knocked out for years in parts of the liquefied natural gas (LNG) complex, and a meaningful share of global LNG trade runs through vulnerable routes. Shortages are being amplified by quota systems across countries, tightening availability across sectors.

 

That combination changes the transmission. Yes, it’s inflationary. But it’s also more growth-negative, because it can disrupt production directly.

 

If the energy shock persists for a few more weeks, the growth drag could begin to outweigh the inflation shock. That’s when it starts to feel uncomfortably familiar — reminiscent of the pandemic economy, at least in a few sectors.

 

But let’s not get too carried away. The pandemic growth disruption was far more severe and economy-wide. The energy-driven shock, in contrast, hits some sectors (like energy-intensive manufacturing) more than others (e.g. information technology services). And India’s starting point this time is more robust: Growth is stronger, inflation is lower, and the trade deficit is narrower than on the eve of the pandemic.

 

Still, the parallel is becoming conceivable: A significant growth disruption to the economy, if the current shock lasts long enough.

 

So far, the fear of inflation has outstripped the fear of growth. You can see it in corporate sentiment and in markets: Bond yields increased in the first month of the energy shock. That’s very different from the early pandemic period, when fears of a demand collapse led to significant easing.

 

But if this shock continues and the growth disruption shows up more starkly, that balance can flip. And the pandemic could offer clear lessons on what to do, and more importantly, what to avoid.

 

The one big global takeaway from the pandemic is that, even before supply disruption was addressed, a sharp rise in demand, triggered by loose policy and high household savings, left the global economy with high inflation, which lasted for several years.

 

The lesson for the current shock is not to stimulate demand before supply is fully repaired. But this is a tough balancing act. Policymakers don’t want to stimulate so much that the economy is left with sticky inflation. But neither do they want to tighten too much, such that there is an even bigger growth problem than what input shortages are causing.

 

Where do policymakers go?

 

Here comes the concept of neutral policy. One that neither adds to nor subtracts from growth. What does it mean in practice?

 

On the fiscal side, neutral policy means keeping the deficit close to FY26 levels (around 4.4 per cent of gross domestic product for the central government). That’s why raising petrol and diesel pump prices matters. It helps contain the fiscal deficit, especially after the recent oil excise duty cut that adds to revenue losses.

 

On the monetary side, neutral policy should be allowed to fit within “flexible” inflation targeting. The RBI’s framework allows inflation to stay within the 2-6 per cent band in a supply-shock year — rather than forcing inflation back to the 4 per cent point-target immediately.

 

Our inflation model provides a way to think about it. We find that if oil averages below $100/barrel, inflation should remain within 6 per cent. In that world, rate hikes may not be needed.

 

But sustained oil above $100 would likely push inflation beyond 6 per cent. And that’s when hikes become more probable. With Brent averaging around $100 in March, India is at a crossroads.

 

In our base case of oil averaging $80/barrel in 2026, we expect no rate hikes. Using rates purely as a currency defence can be expensive when the growth drag becomes non-linear and intensifies quickly with higher energy prices. It was last done in 2013, when inflation was high and the trade deficit wide. There was a case for cooling the economy. But that’s not the case now.

 

Don’t let the growth shock take you by surprise.

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The author is chief India economist and macro strategist, and Asean economist, HSBC