India's Economy Suffers Broader Fallout from Ongoing Global Headwinds

Economic Impact of West Asia Conflict Continues to Escalate

The West Asia conflict has been ongoing for an extended period, with no lasting resolution in sight. One of the most significant consequences of this conflict is the prolonged closure of the Strait of Hormuz, which has been shut for over 70 days. This has resulted in a severe shortage of crude oil supply, depleting inventories, and exacerbating shipping costs and slowing global trade.

The effects of this crisis are far-reaching and have a cascading impact on various sectors. The current energy shock is the largest on record, with S&P Global estimating that about 16% of global oil supply is unavailable to consumers, primarily in Asia. Additionally, supplies of natural gas, jet fuel, diesel, naphtha, fertilizers, sulfur, and helium have also been disrupted.

The reopening of the Strait is expected to take months, and even then, supply of oil will not normalize immediately. As a result, crude oil prices are likely to remain elevated for most of this fiscal year, with Brent averaging $90-95/barrel, a 32% increase from last fiscal.

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The impact of elevated crude prices will be multifaceted, directly affecting the trade account through imports and influencing growth and inflation through direct and indirect channels. Policy measures will further shape these dynamics.

Three Factors Slowing India's Growth

We identify three key factors that will undermine India's growth this fiscal:

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One, rising input costs and shortages of certain inputs will hit domestic production. Two, exports will decline due to weaker demand from West Asia and the rest of the world, along with slower growth in India's major trade partners, such as the United States and the eurozone, compounded by rising shipping and insurance costs. Three, below-normal rainfall from El Niño will likely hurt agricultural production and test rural demand.

Considering these factors, we expect India's gross domestic product growth to slow to 6.6% this fiscal from 7.6% last fiscal.

Government's Approach Will Influence Inflation Trajectory

Inflationary pressures are at the core of the current energy shock. However, India's Consumer Price Index (CPI) inflation has so far remained suppressed, with the first two months since the conflict started seeing CPI inflation record a mild lift from 3.2% in February to 3.4-3.5% in March and April. Indian consumers have largely been shielded from the global energy shock so far, mainly because the government has kept transport fuel prices stable. Goods and services tax cuts have also helped limit the rise in core inflation (CPI excluding food and fuel) so far.

However, higher-for-longer crude prices are expected to lead producers to pass more of their input cost increases onto retail prices in the coming months. We expect core inflation, in particular, to go higher as producers pass on their costs, though the government's direct influence over fuel prices is still a key factor to watch.

Food inflation is likely to rise from the unusual deflationary rates reached last fiscal, with a weak monsoon and heatwaves posing upside risks. We see headline inflation climbing to 5.1% this fiscal due to persistently high crude prices and weather risks.

While India cannot do much in the short term to counter such a large energy shock, it serves as a strong reminder that building substantial energy resilience is a strategic necessity for the long term to sustain growth. The rising frequency of global shocks is a clarion call for such ringfencing.