The Middle East geopolitical shock has accentuated uncertainties around a downside shift in the baseline of most macroeconomic variables and distended the uncertainty bands around the baseline. The US miscalculation has produced a game of chicken. Either party is finding it difficult to swerve (“chicken out”). The fuzzy political signals have magnified the roller-coasters in the financial markets. So, financial conditions can change abruptly, and fissures can get exposed in no time.
Only the brave can predict the end game or provide any macroeconomic forecasts with reasonable faith. It remains to be seen what the Reserve Bank will put out on April 8 as it needs to credibly address the Lucas critique — forecasts based on past data when underlying behavioural relationships change are erroneous.
Volatility, Uncertainty, Complexity, and Ambiguity (VUCA) have spiked. The market fear gauge, CBOE VIX, rose from 13.5 towards the end 2025 to over 30 by end-March 2026. It is now in line with the average VIX during the global financial crisis (GFC) and higher than the pandemic average.
Similarly, MOVE, the bond market equivalent for VIX, doubled and CBOE Crude Oil ETF Volatility Index has nearly trebled. The environment is Brittle, Anxious, Non-linear and Incomprehensible (BANI).
Till the Strait of Hormuz is unclogged, the baseline will need to be marked down substantially. Globally, 20 per cent of the total oil supplies, 20 per cent of LNG, 30 per cent of the LPG transit through this Strait and tankers become sitting ducks at its narrowest point.
The US plan to attack Kharg Island is a ‘Devil’s Alternative’. Crippling its energy infrastructure could boomerang by taking energy prices through the roof, driving Brent past the previous peak of $144 a barrel during the GFC.
Nearly half of India’s crude oil supplies, 90 per cent of its LPG imports or 54 per cent of its LPG needs, and 55 per cent of its LNG imports or 27 per cent of its consumption were routed through the Strait of Hormuz.
India is now diversifying its sources in 2026, routing its supplies through the Cape of Good Hope and Bab-el-Mandeb strait.
Rethinking baselines
Yet, activity levels will plunge if supply chain disruptions persist for over a quarter. Soaring commercial transport costs will cause aggregate demand to collapse. LPG and LNG shortages can add to a pervasive slowdown.
The IMF had projected global growth at 3.3 per cent in January 2026. Its projection models suggest that a 10 per cent sustained increase in crude oil prices, results in 0.1-0.2 per cent drop in global output. Its 2026 projections were based on an average oil price of $62 a barrel. Brent future curve trades at $109 till June after which it goes into backwardation. Oil prices could tumble to $60 a barrel if the war gets resolved or if global economy goes into deep recession.
Based on current futures curve, the IMF needs to revise its 2026 oil projection to around $85. The global growth could then be projected as low as 2.7 per cent. However, judging by the past conservatism and its compulsion to placate its largest shareholder, the IMF may come up with a more benign baseline on April 14 at 3 per cent or a notch lower. Its risk scenarios will show a sharper fall.
Outlook projections
The RBI’s empirics suggest that if global growth drops by 100 basis points (bps), India’s growth will fall by 30 bps and inflation will rise by 15 bps. If global crude oil prices rise by 10 per cent, inflation will rise by 30 bps and growth may fall by 15 bps. These projections will need to be revisited as the oil shock will likely persist with further devastation. It could take 2-3 year to rebuild supply chains. Also, the new GDP and CPI series may require small recalibration of forecasts. The ability of the RBI’s Quarterly Projection Model (QPM) 2.0 to capture multiple shocks will get severely tested. The supply-side shock will generate cost push inflation. Core inflation could be elevated in H1 but falling in H2 as demand collapses and government spending may provide only a partial offset.
India’s baseline growth for 2026-27 was projected at 6.8-7.2 per cent by Economic Survey. The RBI’s structural model projections in October had placed it at 6.6 per cent though with a wide uncertainty band. Subsequent policy projections placed the H1 growth at 7 per cent. Given these parameters, it is more likely that the RBI may pull down its full year growth projection to about 6.5 per cent, while providing upside and downside scenarios.
The RBI’s structural models predicted an average inflation of 4.5 per cent in 2026-27, though its February projections indicated 4.1 per cent inflation in H1. However, oil price shock and sliding rupee exchange rate may prompt the RBI to raise its baseline to around 4.6 per cent, and Q3 projection could be more in the vicinity of 5.4 per cent.
Dealing with stagflation
Stagflationary shocks are a nightmare for monetary policy. Textbook advice is to tighten monetary policy to reduce demand and break inflationary expectations even at the cost of growth further. Yet, recent central bank experiences suggest that the RBI can hold rates keeping stance neutral till inflation expectations rise. The Fed is unlikely to raise rates, though BoJ and ECB might. So, the trilemma can be deftly managed. The RBI may also need to maintain liquidity in surplus mode but not leave too much on the table lest the RBI’s recent forex measures can get defeated.
The writer, a former RBI ED and MPC member, is currently Professor at IIM Kozhikode. Views are personal
The RBI’s empirics suggest that if global growth drops by 100 basis points, India’s growth will fall by 30 bps and inflation will rise by 15 bps
Published on April 7, 2026