The ongoing Middle East war marks the most significant external economic shock to India since Russia’s invasion of Ukraine in 2022. The knock-on impact is evident in crude oil benchmarks, currency volatility, and investor sentiment. For India, the way forward requires a balancing act of managing energy security, fiscal resilience, regulatory interventions, and trade diversification. Securing India’s economic interests will depend on navigating geopolitical reordering and buttressing domestic growth. 

The energy supply shock 

India’s approach to addressing the energy supply shock will be multi-dimensional. It will involve diversification of import sources, continuing negotiations with Iran for safe passage of India-flagged vessels through the Strait of Hormuz, and domestic interventions including intermittent supply restrictions for the commercial sector while prioritising households and essential services. 

However, higher input costs and likely depreciation of the Indian rupee will drive fiscal and financial policy shifts, as these factors will test domestic demand resilience and increase inflationary pressure through 2026. The war is also likely to trigger changes in India’s trade and investment policies, given that India’s significant trading partners are impacted in the war – including the US, Israel, Iran, and Gulf Cooperation Council (GCC) countries. 

An evolving fiscal strategy 

India’s fiscal strategy since after Covid-19 represented discipline, with India building back its fiscal reserves. The central government’s fiscal deficit declined from 9.2% of GDP in FY2020–21 to an estimated 4.4% in FY2025–26. The government also boosted growth-supporting infrastructure spending to an average of 3.2% of GDP over the past three fiscal years. 

The shift toward investment and development-oriented spending is permitted by a steady reduction of fuel and fertilizer subsidies, enabled by lower commodity prices. This framework likely needs revision. The government has already sought Parliament’s approval for a ₹2.8 trillion supplementary budget for FY2025–26, largely to fund additional energy and food subsidies, and a proposed ₹1 trillion “economic stabilization fund.” It is a notable signal that the government is openly leaning toward a countercyclical fiscal stance to cushion global shocks. 

The medium-term fiscal strategy is likely to retain its objective to bring the central government’s debt-to-GDP ratio from an estimated 56.1% of GDP in FY2025–26 to 50% by FY2030–31, plus or minus 1 percentage point. To meet this objective would imply that beyond the one-year outlook, the government will likely need to shrink its allocation for infrastructure-linked capital expenditure, a key driver of growth in FY2024–25 and FY2025–26. 

“Self-sufficiency” as strategic insurance 

Geopolitical developments will also compel a rethink in India’s industrial policy. India will be further keen to prioritise strategic self-sufficiency: diversifying risks across suppliers and enabling deeper manufacturing ecosystems at home. 

The Indian government announced a consequential shift in its regulatory position on March 11: an easing of foreign direct investment (FDI) rules for Chinese investors. The 2020 restrictions, imposed amid security concerns, have been partly diluted. As noted, FDI below 10% beneficial ownership will now bypass mandatory government approval in non-sensitive sectors, while strategic ones like renewables will face a fast-tracked, 60-day clearance process. 

This shift is more about risk management than widespread rapprochement. China remains a critical supplier of intermediate components in solar PV and semiconductor chains, and India’s pragmatic bet is to balance dependency with controlled engagement by reducing the risk of ad-hoc supply disruptions and to support domestic development. The government is also likely to scale back domestic content obligations in renewables and offer targeted tax incentives to attract investors from China, Japan, and Taiwan. 

A similar approach is likely for the defense sector. Expanded FDI ceilings for trusted partners alongside strong technology-transfer clauses will be likely. The more traditional import-substitution logic is giving way to co-production and innovation-driven collaboration, intended to bolster India’s national security objectives and economic options. 

The diversification imperative 

The Gulf Cooperation Council (GCC) is fundamental to Indian interests, both as a source of energy and as home to almost half of India’s 18.5 million overseas workers in 2024. The Indian government will remain committed and is also likely to pursue diversification. 

Gas sourcing diversification talks with Australia, the U.S., and with Mozambique and Nigeria are likely to be accelerated, with Indian public-sector firms likely to pursue equity stakes in upstream projects. For fertilizers, contracts with Indonesia, Russia, and Morocco will likely be fast-tracked given the necessity with the sowing season approaching in June. The Indian objective will straddle multi-alignment and risk of overexposure. 

The diversification imperative will also be replied to overseas employment and avenue for remittances. India is likely to seek faster efforts to continue and complete trade agreement negotiations with countries within the Association of Southeast Asian Nations (ASEAN), Latin America and countries in Europe that are not part of the EU. In these free trade agreements (FTAs)’ negotiations, India is likely to emphasize trade in services, with specific references to allow for professional and vocation-specific visas. 

While the share of Indian workers outside the GCC has steadily risen — especially in IT services in the US and the UK — diversification of employment opportunities will be a priority given that inward remittances accounted for 3.4% of India’s GDP in fiscal year 2024–25, which is likely to be affected by the ongoing war. 

The age of geopolitical agility 

The range of Indian responses to the Middle East war stem from a broader acknowledgment that economic and energy resilience in 2026 is dependent on demonstrating geopolitical agility. The government’s creation of an “economic stabilization fund”, and its likely evolving fiscal and trade posture, elucidate this understanding. 

(Kumar is Head of Asia-Pacific Country & Co-Lead, India Research Chapter, S&P Global Market Intelligence; Luchnikava-Schorsch, Head of Asia-Pacific Economics, S&P Global Market Intelligence. Views are personal.)