- We see the Indian Rupee as vulnerable and USD/INR likely rising above the 95 levels if the Iran and Middle East conflict is sustained and the Strait of Hormuz remains closed, with Brent oil prices returning back to the US$100/bbl at the time of our writing: While we do not yet know how the Iran and Middle East conflict will play out from here, it’s important to stress our current base case USD/INR forecast of 92.00 by Mar 2026 and 93.50 by Dec 2026 assumes a de-escalation after March 2026 and implicitly for oil prices to fall towards pre-Iran conflict levels over time. As a sensitivity analysis, we think that if oil prices are sustained at US$100/bbl, USD/INR could end the year at 95.50. In a left tail risk scenario if oil sustains at US$120/bbl coupled with meaningful energy shortages, we think USD/INR at 97.50 and even higher will look achievable. Of course, it is important to stress that there are many shades of grey here including the duration of the crisis, but overall we see these as reasonable given the meaningfully different nature of the crisis.
- This time is different in this crisis - it is not just about higher oil prices but a potential looming energy shortage, with India and Asia disproportionately hit by a prolonged Strait of Hormuz closure: While this applies to the rest of Asia as well, the vulnerability specifically in India’s case comes from Liquified Petroleum Gas (LPG), with virtually all of India’s LPG and Natural Gas Liquids imports coming from the Middle East. In addition, 60% of India’s imports of natural gas comes from the Middle East, and in particular Qatar. With natural gas a notoriously difficult energy product to store and also transport, the potential for a prolonged disruption is also significant. Both these factors in natural gas and LPG shortages could have spillovers to other areas such as fertiliser and food production, and as such growth and inflation as well. India’s imports of crude oil and refined petroleum products are more diversified, with a likely shift towards importing more from alternative sources such as Russia and West Africa as well in the near-term to ensure energy security.
- The indirect effects across a range of sectors could also be meaningful for India beyond the first order impact, and ultimately points to a stagflationary environment of higher inflation and weaker growth with a weaker Indian Rupee a key outcome as well. With possible production and supply chain disruptions negatively impacting energy-intensive sectors such as manufacturing, transportation, travel, and food production, a lengthy Strait of Hormuz closure scenario may well morph into something akin to COVID lockdowns and coupled with sharp increases in commodity prices, but more concentrated in specific sectors given the very different origin of today’s shock. For India’s case in particular, key vulnerabilities include:
- First, fertiliser prices and food costs. India imports around 40% of its fertiliser needs directly from the Middle East, and this compares with around 33% in Thailand’s case and less than 10% across most Asian countries. Globally 15% of overall fertiliser and closer to 20-30% of urea-based fertilisers are dependent on the Middle East region. All these could over time have some spillover impact to global food prices and hence also inflation, the impact which may only be seen from 2H2026 including for India.
- Second, India has stronger direct trade exposure with Middle East. India is more leveraged towards the Middle East for trade relative to other Asian countries. For instance, 16% of India’s non-energy exports goes to the Middle East, while around 11% of non-energy imports comes from the Middle East. Meanwhile, key products that India’s is quite exposed to in the Middle east includes gems and jewellery, with 32% of India’s non-energy imports and 29% of India’s non-energy exports coming from the Middle East. Other key industries and sectors susceptible to supply chain disruptions include aircraft parts (45% of non-energy imports and 56% of non-energy exports), aluminium (19% of non-energy imports), plastics and chemicals (15% of non-energy imports), and to some extent vehicles and autos (13% of non-energy exports).
- Third, travel and transportation. Across Asia, India is relatively more susceptible to shocks arising from the tourism and travel sector, with slightly less than 3% of total tourist arrivals coming from the Middle East. Nonetheless, this number likely understates the possible impact to the travel and transportation sector for India. With transportation hubs in the Middle East such as Doha and Dubai becoming more important transit points such as between Europe and Asia especially after the Russia-Ukraine war, a prolonged air travel disruption could fundamentally change the economics of air travel in some ways, including for the air transport sector in India. In addition, air cargo and container freight cost spikes could also add further to costs from supply chain disruptions.
- Fourth, remittances. Around 30% of India’s remittances comes from the Middle East, making up slightly more than 1% of GDP of annual USD inflows to support the balance of payments and the Indian Rupee. Meanwhile, a sizeable 50% of overseas workers from India goes to the Middle East. The broader context for India’s remittances is that growth was likely to slow down somewhat with tighter immigration measures in the US even before the Iran conflict, and if the Middle East Crisis is prolonged, it could also be another factor weighing on remittances.
- The good news for India is that: 1) its economy is more domestic oriented, 2) inflation is still quite well managed today, 3) there is some fuel inventory buffer in some products. Nonetheless, these advantages may not last forever as the assessment of the impact to India is very much dependent on the duration of the crisis. While the government has said that it holds roughly 50 days of crude oil and refined product cover for instance, we are already seeing some signs of stress in products such as LPG where import dependence is most acute. This has led to some concerns around disruptions to food and retail outlets. Meanwhile, a slowdown in the global economy coupled with negative spillovers through a weaker INR and higher rate structural will no doubt still transmit to India corporates and households, even if right now a prolonged Strait of Hormuz is still not our base case.
- Overall, we estimate that every US$10/bbl increase in oil prices cuts GDP growth in India by around 0.1-0.2pp and raises inflation by around 0.2pp in India. These historical sensitivities however likely under-estimates the macro impact, because the specific transmission mechanisms in this crisis may not just be about oil prices, but also includes potential energy shortages, meaningful negative indirect spillovers across sectors over time, coupled with non-linear effects as oil prices rise above certain thresholds (as mentioned above). Our current GDP forecasts for India is 7% for FY2026/27, and if oil prices rise above our baseline assumption of US$70/bbl say to US$100/bbl on a sustained basis, growth will likely come in below 6.5% for instance. Meanwhile, we expect Oil Marketing Companies in India to take some of the first hit by implicitly lowering their profit margins given fixed retail gasoline and diesel prices. Nonetheless, even if the pass through is not complete, there will still be price increases in some fuel items such as LPG. Again, if oil prices were to rise to US$100/bbl, average inflation in India will likely rise above 4.5% for FY2026/27.
- Higher oil and energy prices will weigh on INR from FX perspective. We estimate that every US$10/bbl increase in oil prices increases India’s current account deficit by 0.4-0.5% of GDP: As such, if oil prices were to rise towards US$100/bbl, India’s current account deficit will likely move towards the 3% of GDP handle, compared with our baseline forecasts of around 1.5% of GDP. This coupled with still weak capital inflows and continued FDI repatriation suggests that the pressure is likely to increase for INR to weaken through 2026 (see India: Flows before growth – this time is different for INR), including for the reasons mentioned above.
- Will RBI hike rates if the crisis worsens and oil prices spike further? We think the answer is likely “no” right now, but the key distinction is whether this is a temporary supply-side shock perhaps analogous to COVID lockdowns, or proves something more permanent with the potential to raise inflation expectations over time. We think that RBI overall will likely pause on rates for a prolonged period, focus on using FX reserve to manage and smooth volatility in USD/INR to prevent sharp spikes, while also potentially introducing measures to encourage more US Dollar inflows to support INR.
- We remain biased to see INR 10-year yields rising from here, and see India IGB yields creeping higher over time towards the 7% handle, even after taking into account RBI OMO intervention and purchases.