The Middle-East war is causing widespread disruption. But for a number of reasons risk may not be as high as Indian markets seem to be pricing in. There tends to be a knee jerk over-reaction to the impact of global risk-off combined with oil import dependence. This backward looking view neglects many changes.
First, international oil prices crossing $100 serves as a red flag. But in real terms the shock is not as large as past recent shocks. Brent at $112 deflated by headline CPI is 57; in June 2022 the deflated value peaked at 71 and stayed high that year, in March 2012 the peak was 130.
Second, there is an above 50 per cent fall in energy intensity since the 1990s with non-fossil fuel sources accounting for 49 per cent of total installed capacity and several green initiatives in place. The power of oil monopolies has fallen. Oil prices are unlikely to stay high because of alternate sources and substitution possibilities. The impact of oil shocks has reduced worldwide because of these reasons.
Third, the starting point is more benign for macro parameters. Some fall in growth and rise in inflation will still be very far from stagflation.
Fourth, it is not clear yet how persistent the shock will be but even if it is, as a scorched earth policy destroys oil infrastructure, we have dealt well with larger past shocks. When the Ukraine conflict started, oil prices stayed high for a year but next year inflation was in the target band, while high growth continued. Indian resilience was due to growing economic diversity and appropriate policy.
Our FTAs can be used more intensively for trade diversification including in oil sourcing. Supply chains are affected, but we have had practice in finding alternatives. The Indian oil basket will change. We may start refining and exporting Iranian and Russian oil to others, reducing shortages.
Polycrises playbook
If supply disruption persists there is a clear pandemic-Ukraine-playbook to be followed: Counter external shocks as much as possible; keep a moderate liquidity surplus and target support to vulnerable categories but with an automatic sunset clause to prevent perpetual dependence. There were problems in reversing pandemic-time excess liquidity, and with inflation possibly around the corner liquidity infusions have to be measured.
But well-designed support, not tightening, is required in tough times and this worked well in handling recent shocks. We have experience and now just need to apply that consistently.
The government is absorbing much of the current shock, since it may be transient. Counter-cyclical excise cuts limit the pass through to domestic inflation. There is space since the benefit of earlier soft oil prices was not fully passed on to consumers.
While pass through must rise if shocks persist, longer term reforms can moderate it if they act to reduce vulnerabilities. The frontier on substitution and diversification can be pushed. We are surplus in ethanol production and already blending has been mandated; distribution of piped natural gas is being enabled. Power distribution reforms will allow green power generation to be fully utilised. Inefficiencies in our fertilizer policy can be reduced and natural farming promoted. When crises force through otherwise intractable reforms future outcomes improve.
The equilibrium real repo rate will stay positive to anchor inflation expectations but will fall below unity as growth slows. Since currently inflation is low, there is space in this policy for the MPC to pause and watch outcomes. A neutral stance will allow data-based response as required.
Rupee: the other 100s
But especially when markets are nervous, appropriate communication and guidance is essential. In the February policy there was no clear communication on buying support for G-secs, even though the intent was there. Ten-year G-sec yields rose, disrupting the transmission of rate cuts. Market concern was since durable liquidity was high, open market operations would not occur. Reassurance was required about specific types of liquidity not just aggregate liquidity.
Currently the rupee is under stress. Further implications of the ‘market determined but act to prevent excess volatility’ position need to be drawn out. Unabated excess volatility leads to persistent misalignment, such as a real effective exchange rate (REER) that is almost 10 per cent depreciated over its equilibrium level. Research indicates a REER of 100 remains the equilibrium value. A regime that acts against excess volatility also has to counter this. Rupee depreciation exceeded that of other emerging market (EM) currencies in 2025, but it is continuing to depreciate resulting in severe over-shooting, further raising the cost of oil imports.
During global risk-offs EM currencies are subject to sentiment, overreaction and self-fulfilling panics. Over-depreciation, instead of acting as a shock-absorber, only leads to bets placed to profit from more depreciation. 100 can become a focus for a nominal exchange rate that is nearing it.
Balance is very important. While in 2024 intervention in foreign exchange (FX) markets was too much, in 2025 it was too little. RBI cannot absorb all market-risk but neither can it leave markets to themselves.
In 2013 a hands-off led to a steep depreciation that reversed after a series of intervention, although macro inflation, the current account and fiscal deficit were much worse. Among the most successful measures were a special FX window for oil imports, increasing overseas borrowing limits for banks and a calming speech by the new governor who proceeded to do much more FX intervention. Closing net open positions worked only temporarily and raising interest rates did not work.
During volatile times, especially, the RBI can buy and sell FX to smooth small daily mismatches using their data and knowledge of market microstructure. The reserves are more than adequate for that, dips have always been made up in time. EMs accumulate reserves precisely to have alternatives for a costly interest rate defence. Moreover, such a defence is not compatible with inflation targeting.
It would help to point out that since the 1990s, after large deviations, there always were reversals to a REER of 100. Working with markets does better than forcing them. Both time-dependent assurance as well as hawkish or laissez faire guidance are dangerous in volatile times. But since markets tend to over-react they can be guided broadly towards the equilibrium real rates that affect activity, preventing persistent misalignment. FPI is waiting to be confident of reversal before coming back.
The writer Professor Emeritus, IGIDR
Published on April 7, 2026