West Asia Tensions Ease, Improving India's Fiscal Outlook

New Delhi: A sharp decline in global crude oil prices following the easing of tensions in West Asia has improved India's fiscal outlook, with economists now expecting a much smaller slippage from the Centre's fiscal deficit target of 4.3% of gross domestic product (GDP) for 2026-27 than anticipated a few weeks ago.

While economists continue to caution that subsidy pressures and the possibility of an El Nino -induced hit to agriculture and rural incomes remain, the consensus has shifted in favour of a narrower fiscal gap as lower energy prices reduce the government's subsidy burden and improve revenue prospects.

"The sharp dip in global energy prices following the cooling of tensions in West Asia is set to improve the outlook for the government's fiscal position," said Rahul Agrawal, principal economist at ICRA. The ratings agency now expects only a marginal overshoot of the fiscal deficit target compared with its earlier estimate of a 40 basis point slippage, which assumed an average crude oil price of $95 per barrel for 2026-27. A basis point is a hundredth of a percentage point.

The improvement follows the announcement of a US-Iran memorandum of understanding and the reopening of the Strait of Hormuz, developments that have eased concerns over global oil supplies and led to a decline in crude prices.

Oil prices have retreated to their pre-conflict level of about $73 per barrel after surging to more than $100 per barrel. Global crude supplies are expected to improve as Iranian oil exports normalise, production rises following the UAE's exit from the oil cartel OPEC and Venezuela's oil exports increase.

Economists see much smaller slippage from fiscal deficit target of 4.3% of GDP for 2026-27

"However, over the near-term a higher demand by countries to rebuild their oil reserves that had depleted over the course of the conflict could absorb some of the higher supply," said Sarbartho Mukherjee, senior economist at CareEdge Ratings.

Meanwhile, the Centre's fiscal deficit widened to ₹1.6 lakh crore or 9.6% of the 2026-27 budget estimate during April-May, according to official data released this week.

CareEdge Ratings had estimated the fiscal burden of excise duty cuts, higher fertiliser bill and lower tax collection at about 0.5% of GDP in 2026-27.

"But the impact is likely to be much lower given the recent positive developments and provided the ceasefire holds in the region," Mukherjee said.

With crude prices retreating, the government may have room to partially reverse excise duty cuts, limiting the impact on public finances while allowing oil marketing companies to continue absorbing part of the adjustment, he said. Lower international urea prices, which have fallen below pre-conflict levels, are also expected to reduce the fertiliser subsidy bill.

Despite the improving outlook, economists remain cautious about fiscal consolidation. Though the decline in crude prices and currency appreciation are positive developments, their sustainability will determine whether the fiscal deficit target is achieved.

"The fiscal arithmetic appears challenging considering fuel and fertiliser subsidies and expected government support to cushion the El Nino impact on agricultural production and farm income," said Megha Arora, director, India Ratings and Research. On the receipts side, disinvestment proceeds, asset monetisation, elevated customs duty on gold and silver and possibly increased corporate tax revenue due to expected higher nominal GDP are likely to lend support, Arora added.

Radhika Rao, senior economist and executive director at DBS Bank, also expects some fiscal slippage but believes it is unlikely to materially alter investor sentiment.

She estimates that the fiscal deficit could exceed the budget target by about 0.3% of GDP after accounting for the cost of excise duty reductions and higher subsidy spending, partly offset by higher non-tax revenues, an economic stabilisation fund buffer and stronger nominal GDP growth.

“Markets and rating agencies are likely to look past this modest slippage, factoring in the broader positive track record of fiscal consolidation at the centre in recent years,” Rao said.