West Asia conflict: inflation risks, FY2026-27 outlook

A fresh external shock, with India’s buffers in focus

India is facing a tougher macro backdrop as the ongoing conflict in West Asia turns into a supply-side shock for energy, fertilisers, trade and financial flows. In its Monthly Economic Review for April, the finance ministry said the risks from the war have risen, but added that strong domestic demand, policy buffers, a resilient financial system and continued public investment should provide some insulation. The report frames the challenge as a mix of external turbulence and domestic resilience, with the policy focus on sustaining growth while protecting medium-term fiscal and external stability.

The central message is cautious. Prolonged uncertainty can strain macro stability, especially if it disrupts essential imports and raises costs across the economy. At the same time, the review signals that India is not entering this period from a position of weakness, pointing to domestic demand and institutional buffers.

What the finance ministry’s April review flagged

The finance ministry described the West Asia conflict as a significant supply-side shock, with rising risks to inflation, trade and financial flows. It said the shock is visible in the economy and that an accompanying demand compression is a serious concern, given high prices, rising inflation and a reduced pace of economic activity.

The review also highlighted a confidence channel. It said the conflict has dented investors’ confidence, disproportionately affecting Emerging Markets and Developing Economies (EMDEs), including India. That matters because shifts in global risk appetite can quickly influence currency moves and portfolio flows.

Energy and fertiliser supplies are the key fault lines

The review pointed to prolonged uncertainty around energy and fertiliser supplies as a direct test of macroeconomic resilience. It also noted that repairing damage to oil and gas production and supply infrastructure in the Gulf region may take several months. A longer repair cycle can keep commodity markets unsettled and sustain input cost pressures for domestic producers.

The report emphasised the wide dependence of downstream industries on the petroleum sector, suggesting that input cost pressures could be felt widely across the economy. This is important for investors because broad-based cost increases can affect corporate margins and household purchasing power simultaneously.

Monsoon risk adds a second supply shock

Alongside geopolitical stress, the finance ministry flagged weather as a major variable. The El Niño Southern Oscillation (ENSO) is expected to keep India’s Southwest monsoon below normal, and the report added that most rainfall districts are expected to receive below-normal rainfall this season.

This combination can be challenging because energy and fertiliser costs already influence farm economics, and a weaker monsoon can add pressure on agricultural output and food prices. The review explicitly noted that, if a gradual recovery in Gulf supplies is not supported by a good kharif output amid possible El Niño conditions, the headline inflation shock could spill over to core inflation through a cost-push channel.

How inflation can turn cost-push

The report warned that inflation may become cost-push if businesses and producers pass on higher input costs to protect profit margins. It also highlighted that the rupee’s weakening is another pressure point for domestic inflation, as it can raise import prices.

On the potential spillover from headline to core inflation, the report said the strength and breadth of that spillover will depend on factors such as the size of the shock, differences in pass-through duration across markets and commodities, price flexibility or rigidity in sectoral markets, and energy intensity across sectors.

Growth outlook: strong prints, but a clouded FY2026-27 setup

The review said India enters FY2026-27 at the intersection of domestic resilience and external turbulence. It referenced an encouraging 7-7.4 percent forecast for the upcoming financial year, but said the macro outlook has been altered by the war in West Asia.

It also stated that the Indian economy is estimated to grow at 7.6 percent, describing it as the strongest in recent years. Even with that momentum, the report’s risk assessment is asymmetric: risks are tilted to the upside for inflation, fiscal and external deficits, and to the downside for economic growth.

Policy response: keeping growth going while protecting stability

The finance ministry said that while striving to sustain economic growth, policy is expected to safeguard medium-term fiscal and external stability. On near-term cost pressures in critical sectors such as agriculture, it said the government has taken measures including increased allocation of natural gas to fertiliser production, waiver of customs duty, and a 12 percent increase in nutrient-based subsidy for the upcoming kharif season.

These measures are positioned as targeted support to contain spillovers from global supply disruptions into domestic prices and farm input availability.

Financial stability: assessment remains constructive

The review said the West Asia crisis is not expected to adversely affect financial stability. It cited strong indicators for capital adequacy, liquidity and asset quality in both scheduled commercial banks (SCBs) and non-banking financial companies (NBFCs).

It also said the RBI will continue its proactive approach to ensure adequate liquidity to meet the economy’s productive needs. This point matters for markets because a stable domestic financial system can reduce the chance that an external shock turns into a credit squeeze.

RBI bulletin: trade flows, activity indicators, and spillover risks

Separate from the finance ministry review, an article on the “State of the Economy” in the RBI’s April bulletin said supply dislocations arising from the West Asia conflict, which is close to two months old, can turn into a demand shock and warrant continuous assessment. It also said supply disruptions and weather-related uncertainties have increased upside risks to inflation, though inflation remains within the tolerance band.

The RBI article noted that the conflict intensified pressures on global supply chains in March, with some easing observed in the first half of April. It added that in March, high-frequency indicators showed divergent trends, with demand conditions resilient but pockets of slowdown visible in indicators such as port cargo, air passenger traffic and purchasing managers’ outlook.

On the external sector, the RBI bulletin said the conflict led to an average 54 percent decline in exports and imports from West Asia in March. It also said a slowdown in imports and expansion in exports narrowed the trade deficit to a nine-month low in March, while foreign portfolio investment flows remained volatile and net foreign direct investment turned positive in February.

Key facts and figures at a glance

What investors and businesses should watch next

The reports point to a few near-term variables that can move quickly: the duration of the West Asia conflict, the pace of repair to Gulf oil and gas infrastructure, and the extent of supply chain normalisation. Domestically, the monsoon outcome and fertiliser availability will be closely watched for their inflation implications.

For markets, the linkage is straightforward but conditional. The finance ministry has warned of upside risks to inflation and deficits and downside risks to growth, while the RBI has flagged the possibility of second-round effects if the supply shock becomes a demand shock. The next data points that could clarify the trajectory include updates on rainfall distribution, trends in input costs, and high-frequency activity indicators that the RBI has already identified as showing early signs of deceleration.