Balancing on the Brink: India’s Economic Policy in a Time of Crisis

India is entering a phase of economic stress that is still forming but is increasingly difficult to ignore. It is not yet a full-blown crisis. But the underlying pressures—external and domestic—are beginning to align in ways that have historically proved destabilising.

The trigger this time is unmistakably external. Crude oil prices, now around $110 per barrel, are straining the macroeconomic balance of a country that imports over 85 per cent of its energy needs. The transmission is already visible. The rupee has weakened sharply, breaching ₹94 to the dollar. Imported inflation is building through fuel and input costs. Transport and logistics costs have risen, and in parts of the petrochemical value chain, particularly ancillary industries, production is beginning to contract under cost pressure.

More concerning is the trajectory. The US–Israel–Iran conflict shows no sign of resolution, raising the risk of prolonged disruption to energy supply chains. Concerns over LPG availability and possible stress in petrol and diesel supplies are beginning to influence expectations. What is unfolding is not a sudden rupture, but a steady tightening of external balances, domestic cost structures, and financial conditions.

Active Policy, Limited Direction
The policy response has been active, but largely defensive. The government continues to prioritise growth through elevated public capital expenditure, while maintaining a stated path of fiscal consolidation. Inflation is being managed through a mix of monetary restraint and administrative intervention—export controls, buffer releases, and indirect tax adjustments to moderate fuel price pass-through. The Reserve Bank of India has intervened selectively in foreign exchange markets, allowing the rupee to adjust while attempting to prevent disorderly volatility.

These measures have helped contain instability. But containment is not control. The economy is being managed, but not decisively steered.

The Cost of Policy Incoherence
The difficulty lies not in the absence of policy action, but in the absence of coherence. Multiple objectives—growth, inflation control, fiscal consolidation, and external stability—are being pursued simultaneously, without a clearly signalled hierarchy. For markets and investors, this creates ambiguity. Policy intent becomes harder to infer, and uncertainty rises even when underlying fundamentals remain relatively stable.

This is reinforced by weak sequencing. Measures to support growth, contain inflation, and manage the external sector are being implemented in parallel rather than in a defined order. Each intervention addresses an immediate concern, but their interaction does not produce a cumulative effect.

There is also a clear tilt toward mitigation rather than correction. Fuel price pressures are managed through tax adjustments rather than full pass-through. Food inflation is addressed through export controls rather than structural supply responses. These choices cushion the immediate shock but leave underlying distortions intact. Over time, that erodes credibility.

Institutionally, decision-making appears more centralised, with less visible space for independent signalling. In periods of stress, credibility is strengthened when policy is both coordinated and independently validated. That balance appears weaker.

When External Credibility Becomes a Constraint
The external dimension now compounds these pressures. There is a growing perception—both domestically and across parts of the Global South—that India’s recent tilt toward the US–Israel axis has been ill-timed, particularly amid a widening West Asian conflict that directly affects its energy security.

Whether or not this perception is entirely fair is secondary. It has economic consequences. It risks narrowing India’s strategic flexibility at a moment when access to energy, diversified supply relationships, and geopolitical balance are critical. It complicates engagement with key energy-producing regions and introduces an additional layer of uncertainty into investor assessments.

A decade ago, external credibility reinforced India’s crisis response. Today, geopolitical signalling risks diluting it.

At the same time, the global environment is less supportive. Energy markets remain volatile, capital flows are more selective, and multilateral institutions are less effective as shock absorbers. External conditions no longer reinforce domestic policy; they increasingly test it.

Lessons from 2012–14: Restoring Direction Before It Is Too Late
The contrast with 2012–14 is instructive. That period saw a sharper and more immediate crisis—current account deficit at 4.8% of GDP, fiscal deficit above 5.5%, inflation near double digits, and a sharply depreciating rupee. 

Yet the response was marked by clarity and coherence. There was a clear articulation of priorities, disciplined sequencing of stabilisation and reform, willingness to take politically difficult decisions, and strong institutional coordination. External engagement reinforced domestic effort, restoring confidence.

More importantly, this clarity translated into outcomes within a short period. Growth, which had slowed to around 5.2% in 2012–13, recovered to 6.9% in 2013–14. The fiscal deficit was reduced from about 5.8% of GDP to 4.5%. The current account deficit narrowed sharply from 4.8% to below 2%. And the rupee, after touching nearly ₹68–69 to the dollar, strengthened to around ₹59 by March 2014.

These were not marginal improvements. They marked a decisive shift in trajectory. Policy did not merely stabilise the economy—it changed expectations.

That is the essential difference from the present. India today is structurally stronger, but policy is less effective in shaping expectations. In 2012–14, policy altered the trajectory. Today, it is largely managing the consequences of external shocks.

The issue, therefore, is not the absence of policy, but the absence of direction. Clarity of purpose and sequencing—what comes first, and why—are what give policy its force in periods of stress. Without that, even active intervention struggles to influence expectations.

The constraints are not unfamiliar. Power pricing continues to embed cross-subsidies that raise production costs. Logistics costs remain elevated, in part due to fuel taxation. Regulatory compliance still weighs disproportionately on smaller firms. Periodic interventions in raw material markets have added uncertainty to supply chains.

None of these can be resolved quickly. But that is not the immediate test. In the present context, even limited, well-chosen movement—on input costs, policy stability, or procedural simplification—would do more than ease pressure. It would establish direction.

That is what distinguished the response in 2012–14. The credibility of policy rested not only on what was done, but on what it made clear—that the direction of travel was understood, and that adjustment would follow.

The current phase is still unfolding. The energy shock persists. Currency pressures remain. Supply-side stress is beginning to surface. The risk is not an abrupt collapse, but a gradual erosion of stability, credibility, and confidence.

The window for pre-emptive action is narrowing—and once it closes, policy will follow events rather than shape them.

*Dr Arvind Mayaram was the Finance Secretary to the Government of India during 2012-14.