Rising external uncertainties: Iran war can complicate economic management

Attacks by the United States (US) and Israel on Iran have intensified, with no early end in sight. Since the objective of the war has not been clearly defined, the outcome is hard to guess. This has created a fair bit of uncertainty, particularly for a country like India. Since India imports more than 85 per cent of the oil it consumes, and most of it from West Asia, both rising prices and supply concerns can significantly complicate macroeconomic management. Brent crude oil prices, for instance, briefly surged on Monday to about $120 a barrel. Although India’s fundamentals are stable, sustained higher prices of oil could put pressure on both external accounts and government finances. From India’s macroeconomic standpoint, it is worth recalling that the Iran war has added to elevated levels of external uncertainties. India was subjected to punitive tariffs by the US in 2025. It was only in February that India and the US agreed to a trade deal. However, following the US Supreme Court judgment, it is not clear when the India-US trade agreement will be finalised.

 

The balance of payments (BoP) data for the third quarter (October-December 2025), released by the Reserve Bank of India last week, showed India faced a BoP deficit of over $24 billion during the quarter as against a deficit of about $10.9 billion in the previous quarter. India usually runs a current-account deficit (CAD), which is financed by flows on the capital account. However, if both the capital and current accounts slip into deficit for a sustained period, managing the external situation could become challenging. Foreign portfolio investors (FPIs), for example, have  sold Indian stocks worth over $22 billion since January last year. One of the reasons for FPIs pulling out of India is global uncertainty. Things could become challenging if the Iran war continues for longer. For instance, the BSE Sensex, the stock-market benchmark, lost over 1.7 per cent on Monday. Thus, a lot will depend on when the war ends and what it achieves. The outlook could worsen if it results in greater instability instead of lasting peace in the region. 

 

Economists expect a CAD of about 1 per cent of the country’s gross domestic product (GDP) this financial year. This could increase to about 1.5 per cent in 2026-27. Estimates, however, can change, depending on the duration and outcomes of the war. Even if the CAD remains at the levels projected, financing could become a challenge if global uncertainty remains elevated. Notably, India did well when faced with disruption on trade. It continuously negotiated with the US and concluded the much-awaited trade deal with the European Union. However, in the present circumstances, it cannot influence outcomes. While India has high foreign-exchange reserves, worth over $728 billion, which will help reduce volatility in currency markets, a sustained deficit on the capital account will put pressure on the currency.

 

Higher energy prices will also affect government finances. Oil companies may find it difficult to pass on higher costs to consumers since retail prices are not updated regularly anymore. The government may choose to reduce taxes or fund under-recoveries directly from the Budget. Thus, government finances are likely to take a hit even if higher costs are partially absorbed in retail prices. The government may also have to allocate more for fertiliser subsidies. The latest data showed that several ministries are slow in spending. Therefore, some adjustment can be made this financial year to contain expenditure. For next financial year, again, a lot will depend on what happens in West Asia.