The first half of 2026 has been nothing short of a high-speed rollercoaster. The year began on a hopeful note with low crude oil prices, and tariff wars cut short by the US Supreme Court ruling. Many characterised India as being in a Goldilocks period, with low inflation and high growth. However, within a matter of months, the West Asia crisis broke out, resulting in crude oil prices rising above $100 per barrel for nearly two months. The escalation represented not only a pure fuel price shock, but also raised the possibility of supply shortages, with the Strait of Hormuz remaining closed for months.
As if a war in West Asia wasn’t enough to rattle the global economy, even the weather Gods joined in, with the monsoon stalled by strong El Niño conditions. Indeed, international weather agencies have indicated that, at its peak, El Niño conditions could be the strongest since the 1950s.
However, as they say, the night is darkest just before the dawn, and conditions have dramatically improved with the US and Iran reaching a ceasefire agreement. The drop in global crude oil prices was as dramatic as the rise, with prices back at pre-war levels within a matter of weeks. This has defied our expectations of a gradual decline in prices, as production activity in the GCC will take time to normalise. The sharp fall in crude oil prices reflects the forward-looking nature of the market, with markets pricing in fresh supply from Venezuela and Iran, along with a much weaker OPEC cartel.
External Balance
If the agreement between the US and Iran endures, crude oil prices are likely to average around $70/barrel, if not lower, for the rest of 2026-27. The full-year average is expected to settle between $75 and $80. Lower crude oil prices imply that depreciation pressure on the rupee is likely to be much lower, supported by stronger external accounts.
India is one of the world’s largest importers of crude oil and gas. Petroleum imports account for 22% of total merchandise imports. If the 2026-27 Indian crude basket averages between $75 and $80, the current account deficit could be contained at around 1.7% of GDP. This compares with a deficit of more than 2% of GDP if crude oil prices average at $90/barrel.
The lower risk to the current account comes at a time when the capital account has been bolstered by measures taken by the RBI to attract inflows. These include the RBI absorbing the hedge cost for various forms of debt inflows, such as FCNR(B), external commercial borrowings and overseas foreign currency borrowings. The government has also announced complementary measures by removing withholding tax and capital gains tax on government bonds. These initiatives are expected to be extremely effective in attracting capital inflows, as they are lucrative for investors while remaining cost-effective for borrowers.
The balance of payments, which is the sum of the current account and capital account, is expected to turn positive at $30 billion to $40 billion in the current fiscal, compared with a $24 billion deficit last year. The capital inflow scheme will act as a shield against the uncertainties surrounding the US-Iran truce, capping depreciation pressure on the rupee.
There could be brief periods of strength, especially in the July-September quarter, when the majority of the capital inflows are expected to arrive, led by FCNR(B). However, the dip in dollar/rupee will be temporary, as the RBI will absorb dollar inflows and add to forex reserves. The capital inflows through FCNR(B), ECB and OFCB will be automatically absorbed via dollar/rupee buy-swaps. Moreover, the RBI is likely to allow some of the existing swaps on its forward book to mature. As of April 2026, the RBI’s forward book size was already elevated at a net $95 billion short dollar position, out of which $40 billion is maturing by April 2027.
Considering the significantly improved global environment, along with RBI reserve management, the rupee is expected to reach 96 by March 2027. This represents a much more moderate pace of depreciation of just 1%, compared with 11% in the year gone by.
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