West Asia conflict, oil shock push India into ‘reverse Goldilocks’ position | Expert Views
India will be even harder hit. GDP growth will drop from over 7 per cent to around 6-6.5 per cent in 2026 and inflation will rise to over 5 per cent, according to the IIM’s Business Expectations Survey, well above the inflation target of 4 per cent. While at the end of 2025, India was described as a Goldilocks economy, it is now in what is being called “reverse Goldilocks”. The hold on petrol pump price increases because of key state elections cannot last too long without damaging the finances of oil public-sector enterprises (PSEs) and the fiscal deficit targets. LPG prices have already been increased and export duties on diesel and jet fuel have been imposed. The rupee has breached 95 against the dollar and is amongst the weakest currencies in Asia. The Reserve Bank of India (RBI) intervened briefly but realised that this was a losing battle as foreign portfolio investors have pulled over $21 billion from Indian markets since the start of the Iran war due to the oil shock.
The rupee, however, weakened even before the Iran war (see chart 1) and was the weakest Asian currency in 2025, as foreign portfolio investors pulled over $19 billion out of Indian markets. This was due to the tariff shock, with India ending up with 50 per cent tariffs, surprising everyone. But also contributing to this was the much less discussed artificial intelligence (AI) shock, where India’s information technology (IT) sourcing model is perceived to be a loser.
The government has countered this perception through a much-hyped AI summit and announced a comprehensive AI mission to build a robust AI ecosystem by 2030, including creating indigenous smaller AI models and fostering startups and public-private AI projects. But questions remain on whether AI will be a boon or a bane, as India’s big IT companies have not seen fit to invest in AI research and their outsourcing model is taking a hit. How quickly they can use AI to revamp their business model remains to be seen.
Nevertheless, India emerged reasonably well from 2025. But now, the oil shock and war-related supply disruptions have again driven funds out of India and significantly weakened the rupee. The tariff shock has ebbed, as India now pays only a 10 per cent import duty into the United States, the same as others. But Donald Trump is getting trade reviews done and intends to return to selective country tariffs — that dog might still bite; stay tuned.
Oil prices may eventually reverse, but for now, India’s currency has been hit hard again, despite its sizeable reserve holdings (see chart 2), and is among Asia’s weakest currencies. Cumulatively, the Indian rupee has weakened by 10 per cent against the US dollar since the beginning of 2025. As a result, according to the IMF, in dollar terms, India has been eclipsed by the United Kingdom and is now the sixth-largest, not the world’s fifth-largest, economy, with even Bangladesh’s per capita income is now higher than India’s.
The rapid exchange rate depreciation will, of course, help counter another big worry, the current account deficit, which in 2026 may exceed 2 per cent of GDP, a danger level. By making imports more costly and encouraging exports, a weaker rupee will help reduce the current account deficit. But this may be dwarfed by weaker global demand. All past empirical work shows that exports are dependent hugely on global growth — which is weakening. India’s exports to the Gulf states — a major market — have also been hugely impacted by the war. This means finalising and executing the free-trade agreements (FTAs) India has signed, especially with the European Union, the United Kingdom, Australia and now New Zealand will be critical.
The war has affected not just oil but also gas and fertiliser. While reports say India has managed to obtain sufficient fertiliser for the Kharif crop, this might be a time for much-needed reforms in fertiliser, where subsidies will rise by 20 per cent under a business-as-usual model. The over-reliance on subsidised urea (nitrogen) has severely affected soil nutrient ratios, requiring a shift towards nitrogen, phosphorous, and potassium balance. Moving towards direct cash transfers to farmers (e.g., a flat per-acre payment) to replace the current input-based subsidy, allowing market-driven pricing for fertilisers to truly solve inefficiency is long overdue.
India must also look for diversification in its gas needs. The US is a potential source, but the next US administration may not be so keen to export and may cancel plans, as happened under the Biden administration. Had Joe Biden not banned LNG exports, India would not be in so much trouble today with its gas needs. Australia, Russia, Malaysia, and Indonesia may provide a more reliable solution in the future to diversify from the Gulf.
The oil shock will hopefully lead to a faster shift to renewables. The supply disruptions have shown that more physical buffers in oil and other critical inputs are desirable. Longer-term oil contracts with dependable partners like Russia should be made, despite US pressure. While a trade deal with the US is vital, India must signal that it cannot be pushed around at will and has certain key strategic interests.
The author is distinguished visiting scholar, Institute for International Economic Policy, George Washington University
