Fiscals rarely begin with exogenous shocks rippling through economies.
Five weeks after tensions in West Asia turned kinetic, and a good six years after the last global turmoil was set off by the Covid-19 virus, supply chains, trade and financial markets are once again caught in large-scale aftershocks.
The energy price spike triggered by the conflict is morphing into a broader input constraint, particularly natural gas and its derivatives.
This combination of higher prices and tighter supply for critical inputs can pose a systemic risk. For businesses, this is not merely about paying more for inputs but navigating uncertainty around availability and the ability to pass on the higher procured costs.
Manufacturers are facing the first round of effects in India. Over the past three fiscals, firms benefited from a favourable input cost environment, which, alongside improving domestic demand, supported steady margin expansion.
That trend is now reversing. Rising input costs are emerging as a key pressure point, with uneven pricing power limiting the ability to fully pass on costs. An analysis by Crisil Intelligence of 900 companies shows that higher crude and gas prices will shrink overall margins by 50 basis points in fiscal 2027, with some sectors facing steeper margin compression.
Additionally, early high-frequency indicators, also noted by the Monthly Economic Report by the Ministry of Finance, suggest a moderation in supply-side activity following the energy price and availability shock amid resilient demand conditions.
At the same time, the government is attempting to strike a balance between cushioning consumers from a sharp fuel price rise while managing energy supply allocation to industry.
Even with these measures, some degree of stress is unavoidable, particularly if the impact of the shock on supplies persists.
Fiscal policy in this environment is emerging as the primary line of defence, but beyond a point, there will be trade-offs.
Three pressure points on the fisc could emerge as the crisis deepens:
Firstly, higher crude oil prices are being partly offset by excise duty reductions for retail fuel consumption, which may impact revenue.
Secondly, rising fertiliser procurement prices can translate into a higher subsidy burden, an expense the government originally budgeted to cut by ~8% in fiscal 2027.
Thirdly, any moderation in growth could weigh on tax collections, although that also depends on the movement of nominal growth as prices move up.
As of now, these are manageable fiscal pressures, but they remain risks rather than definitive upsides to the fiscal arithmetic.
Importantly, the starting point for the fisc is stronger than in the previous episodes. Over the past few years, the government has worked to create fiscal space by rationalising expenditures, benefitting from revenue buoyancy and bringing down the fiscal deficit significantly below the pandemic peaks. This provides a buffer to respond.
As pressures from the conflict mount, fiscal policy will need to remain agile and adaptive.
This could ultimately involve some temporary widening of the fiscal deficit or selective moderation in expenditures as policymakers navigate another external shock.
If fiscal policy absorbs the immediate impact, then monetary policy faces a more intricate challenge. Beyond managing the growth-inflation trade-off, it must also simultaneously navigate the domestic liquidity management and currency pressures and maintain supportive financial conditions.
This is particularly critical at a time when government borrowing (Centre and states) remains elevated and private sector capital expenditure is beginning to recover.
Premature tightening in financial conditions could disrupt the investment cycle, while accommodation runs the risk of fuelling inflation. Policy calibration becomes pressing and increasingly dependent on the gradually unfolding impact of global developments.
Last fiscal year, there was some tightening in financial conditions, impacted by US tariff moves and uncertainty that caused foreign portfolio outflows.
While fiscal 2026 provided a strong macro starting point for the real economy, financial and currency markets showed some divergence. Despite staying in the comfort zone, Crisil's Financial Conditions Index (FCI) deteriorated to the negative territory during the year. A negative reading in the index signals tighter financial conditions than the long-term average. Much of this was due to large capital outflows after the imposition of higher tariffs on India's exports to the US.
The real economy, in contrast, was supported by strengthening domestic demand.
Consumers remain relatively insulated in the near term owing to government intervention in fuel pricing and earlier tax adjustments from GST rate rationalisation.
However, as input costs increase and food inflation normalises from the recent lows, inflation pressures will build up. If the supply shock persists, it could increase household inflation expectations.
Monetary policy decisions are not only entering a complex territory, but also see space restriction with upside risks to inflation building up.
The combination of rising energy prices and supply constraints introduces clear risks around input costs, corporate margins, fiscal pressures and inflation dynamics.
The real challenge is for fiscal and monetary policy responses to operate within tighter trade-offs.
At one level, this episode may resemble past energy shocks. But two differences stand out, which suggest that the episode may not lend itself to simple conclusions.
First, the silver lining: The macroeconomic starting point is more favourable, allowing better shock absorbers in the near term. Growth remains relatively strong and domestically driven. Retail inflation, while facing upside risks, is low and contained for now, while bank and corporate balance sheets are healthier. Fiscal policy has rebuilt space and the current account, though vulnerable, starts from a more manageable position. These factors collectively enhance the economy's ability to absorb the shock.
Second, the complexity: This is not just an energy price shock but a broader, faster-moving supply disruption with multiple transmission channels. Therefore, unlike the energy shocks in the past, this one is expected to impact production, with the severity of impact tied to the duration and scale of conflict. In fact, supply disruptions could last beyond the duration of the conflict.
At each stage, a more grounded reading of the situation demands attention
The author, Dipti Deshpande, is a Principal Economist at Crisil.
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