West Asia war, rain deficit can hike inflation, drag India's growth: Finmin

New Delhi: The Indian economy faces the challenge of a double whammy-the West Asia war and a below-normal monsoon forecast-posing upside risks to inflation as well as fiscal and external deficits and downside risks to growth, the finance ministry said. But resilient domestic demand, policy buffers, a robust financial system and sustained public investment will act as a cushion, it said in its monthly economic review (MER) for April that was released on Wednesday.

A supply shock is evident in the economy in the wake of the conflict, and any accompanying demand compression will be a serious concern, it said. The review warned against the excessive focus of some countries on short-term growth preservation amid external turmoil.

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Financial stability intact

The review stressed that this should not override broader macroeconomic interests of drawing investment and bolstering domestic capital formation. Such short-term temptations, it said, can potentially harm medium-to-long-term growth prospects by destabilising external balances, the inflation outlook and the currency.

“Long-term growth and development aspirations will be significantly set back. That should be firmly kept in mind,” it cautioned.

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So far, India’s policy response has demonstrated an ability to manage immediate disruptions without losing sight of long-term priorities, it added. The conflict is unlikely to impact India’s financial stability, it stressed, adding that capital adequacy, liquidity, asset quality, and commercial banks’ profitability remain robust.

Five-point agenda

The review offered five prescriptions amid the current crisis. First, the country should prioritise energy security and resilience, without substituting one import dependency for another. A more holistic approach to fix public transportation issues, through the participation of states and other key stakeholders, will improve both energy security and the liveability of Indian cities.

Second, the decriminalisation and deregulation agenda “need not be hostage to external developments,” it said. Regulatory easing that lowers the cost of trade will be critical.

Third, the twin shocks of war and likely deficit rain call for long-overdue policy reforms to remove distorted crop choices and improve farm productivity. The forecast of a below-normal monsoon underscores the urgency of getting agricultural and water policies right. “If not now, when?” it asked.

Fourth, promoting durable trade skills among the youth for building resilience against potential labour displacement driven by artificial intelligence will not only boost domestic manufacturing and services but can also be a source of export earnings. “India’s employment challenge includes but transcends the impact of AI on information technology jobs alone,” the ministry said in the review.

Fifth, the “need for tax policy certainty and predictability has never been greater,” it said, underscoring the caution against an unreasonable focus on short-term growth preservation.

Foreign investment

The review said gross foreign direct investment inflows in FY26 have broken out of recent annual ranges, but the challenge would only intensify in FY27.

Countries are not only weaponising supply chains but also investment flows, making it difficult for both domestic and foreign capital to relocate, it stressed. “India’s task is cut out. All agencies will have to lend their shoulders to attracting capital flows,” it said.

Tax policies, logistics, liveability, a culture of research, development and innovation, and a skilled, fit and healthy population are key to preserving growth, it said.

The review predicted wider trade and current account deficits in FY27.