‘Need enough buffers to deal with any kind of volatility, inflation impact to be seen through multiple channels’, says Nomura’s Sonal Varma

So, Asia is at the epicentre, and within the Asian countries, India gets impacted because we are a net importer. I think the important issue here is the shock that we are facing right now is a combination of the 2022 Russia-Ukraine war and the pandemic — in the sense that this is not just an energy price shock, it is also a physical supply shortage. We have very limited (supply), there are some buffers, some inventory, some cargo that is on shipment at sea, but if this inability to access supply of things like LPG, where more than 90% actually comes through the Strait of Hormuz, the physical shortage of LPG, LNG and crude oil over a period of time will also impact growth adversely to an extent, but more importantly, inflation on the upside. That’s the situation the world is dealing with right now.

What are the channels through which it impacts India?

There are multiple channels through which there will be an inflation impact even if pump prices are kept unchanged. Although, at current oil prices, India’s crude oil basket actually is higher than Brent, which we track on a day-to-day basis. So the oil marketing companies as of now are running a loss of almost Rs 18 per litre, in terms of under-recovery on petrol and diesel. The big question now is — what will be the duration of this shock? If it’s a short-term shock, then it could be absorbed. But if it is more prolonged, then there will need to be some redistribution of this loss between the OMCs and the government and to some extent even consumers as well.

Inflation impacts in multiple ways. This is not just a crude oil price increase, it is also an increase in LNG price as firms are substituting for other forms of energy. For instance, you use coal because natural gas is not available, that’s also pushing up coal prices. Energy lies at the foundation of what we do on a day-to-day basis, so that automatically pushes up the cost of production across the board for companies.

Second, the increase we have seen in things like commercial LPG, in some cases, the unavailability of LPG, this is putting increasing cost pressures for various restaurants, so we could see menu costs getting revised higher. Aviation turbine fuel has gone up again substantially. In fact, this is the important point here — the increase in product prices. Globally, diesel, petrol fuel oil, jet fuel oil, the price increase in products has been substantially more than the increase in price of crude oil. So, as an airline, the operating expense goes up and that basically pushes up airfare, so that automatically feeds into higher services inflation.

This filters into downstream sectors too. For instance, prices of urea are now on the rise and if the fertiliser prices pick up alongside an increase in energy price, then that will, over a period of time, also put some upward pressure on food inflation potentially. And, the downstream sectors use various intermediate inputs that basically get processed from the energy side. So things, for instance, making tiles, cement, packaging, even auto consumer durables, all these sectors, ultimately, actually will see an increase in cost. So, for the manufacturing sector, which in the last one-and-a-half years has seen a substantial moderation in input costs and therefore, an improvement in their profitability, this environment actually leads to higher input cost and a pressure is on their profit margins. And since the increase in cost is so substantial, the ability of firms to just withstand it in their margins will be difficult. So, we are likely to see some pass through of this increase, even in terms of an increase in goods prices, in some categories. I think from food to energy to even the core basket of the CPI, both on goods and services, actually, this has the potential to be quite inflationary. At the end of the day, it boils down to what is the duration of this shock. If this is a few months, the inflationary impact will be less. But if it is more than three months, then there is a greater risk of higher inflation coming through. Those are some of the main channels through which inflation comes through.

The Chief Economic Advisor listed out three scenarios — crude at $90 per barrel, $110 per barrel, and $130 per barrel. You spoke of second-order effects. If crude prices don’t rise sharply, will the growth projections still take a hit?

It does depend on how long prices stay at $100 (per barrel). The situation that we are in right now, where we are hovering around $100 on Brent (crude), in the very near term, it does look like we are still in a period where the impact of physical shortage will probably be visible sometime in April, because there is still some inventory that firms have that they are running down right now or, firms have contracted certain cargo which is already in transit on sea. So, there is some supply that you can depend on, let’s say for the next 25 days, beyond which, it basically becomes a dual price and volume shock. And then the question is — let’s say if the conflict ends and the transmission opens up on the Strait of Hormuz, what is the landing price on energy? Do we settle back at $70-$80 (per barrel), or do we settle at even higher? There is significant uncertainty on how this plays out, so it does make sense to work with various scenarios.

Our assessment right now is that if this is a short-duration impact, let’s say 2-3 months of a peak impact, and then it settles down maybe slightly above where we started out in terms of energy prices, but lower than where we are right now, in that scenario, the growth impact will be negative but it should not be substantially negative. So, for FY27, we are currently working with a real GDP growth assumption of around 7%. Prior to the Iran conflict, our number was closer to 7.1% with upside risk. The reason I say that is if you look at the last 12 months, we have seen a substantial amount of fiscal easing, monetary easing, liquidity easing, macroprudential easing in India, and therefore, the combined impact of this countercyclical policy easing has already sown the seeds of a cyclical recovery. So, a lot of our lead indicators actually do suggest that prior to this conflict, there is this tailwind to some of the domestic cyclical growth sectors that is playing out. Whether it is in car sales or commercial vehicle sales, a lot of this is going to show up in the coming period.

Second, one of the big issues last year has been the 50% US tariff that has now reset lower. So, there should be some positives from that side and third, to the extent that the government is protecting consumers, so, if there is a wedge in terms of government either cutting the excise duty on petrol, diesel, or giving more subsidies to the OMCs, that is, protecting consumers in the process, there is some impact on firms, but the consumers are still protected, credit growth is picking up. So, there are reasons to believe that growth can still be around 7% if we settle on average around $90 per barrel. Now, if you are talking about a scenario where oil goes to $130 and stays there for 2-3 quarters, then we need to think about second-order effects because the extent of demand destruction globally as well as in India would be a lot more substantial. For instance, we will see more pass through to consumers happen in that scenario. There’s a risk that countries globally will turn more protectionist and prevent exports in order to basically boost their own domestic supply. But that can create ripple effects at a global level. Central banks will face a very challenging trade-off between growth and inflation. And, in some scenarios, they will need to make the tough choice of whether they need to raise interest rates in order to prevent second-round effects or inflation expectations from getting anchored.

And then there’s a risk of how capital flows and financial conditions tighten in that environment. So I think, as the Chief Economic Advisor stated, the scenario of $130 over a sustained period of time, is a scenario when non-linear economic effects could lead to greater negative impact on growth. Right now though, if we assume around $90 on average for FY27, with near-term prices higher but then settling down slightly lower, I do think that there are still tailwinds that can support growth. In the next two months, March, April, May, when there is gas rationing, and companies are being forced to reduce their output because of not sufficient supply, there will be some impact on production, but the underlying drivers of growth right now still look reasonable.

You spoke of self-sufficiency. Which areas are at the top of your mind?

Absolutely, because any step we take today to increase our strength will take multiple years to play out. So, this is definitely a long-term strategy. One sort of common theme, because this cuts across different sectors, but one of the common themes is in general — diversification is the name of the game. So, not putting all your eggs in one basket is clearly a strategy that needs to be applied, whether it be about who we are doing trade with, who we are buying energy from, where we are getting investment from, I think diversification is definitely quite important.

Now on the macro side, I think we usually look at foreign exchange reserves as a buffer. In the current environment where you have one shock after the other. And even when you’re running a current account deficit, that’s less than 1% of the GDP, it’s still difficult to actually fund it because you have capital outflows. The need to have higher foreign exchange reserves as a buffer, for instance, becomes quite important.

Two, I think some of the things that you mentioned, like within energy, the immediate priority is to build more inventory and have more buffers. For instance, the government strategic petroleum reserves has around 37 million barrels. The commercial stocks are a bit higher on the private side. But overall, in terms of the number of days of cover, we have on crude oil should be a lot higher. And, similarly having those buffers not just for crude oil but for some of the products, whether it’s on petrol, diesel, LPG, building inventory comes at a cost but there needs to be some buffer on this side.

Simultaneously, from a more longer-term perspective, the question is: what is the kind of energy mix we want to power our economy because we will need a lot more energy going forward. If you look at what’s driving growth going forward globally, a lot of it is actually technology, AI, data centres in investment. And these are very, very energy intensive. So how do we move further away from pure dependence on fossil fuels towards more of both renewables but also the debate on how much should be the share of nuclear power in terms of driving some of our energy needs.

Third, the rare earth is a long-gestation process, in terms of mining, processing, it is going to take multiple years. But it is a critical input on anything with green tech related. This is an important chokepoint globally. And therefore, a focused policy agenda on the entire value chain on rare earth is important. We can also have partnerships with various countries globally which are rich in some of these minerals, so that you also depend on more partners, like-minded partners, to source some of these critical elements. And, finally, on defence, it’s become extremely clear that the geopolitical environment that we are living in, increasing our defence abilities across the spectrum is an important part of the game plan for being robust as a country. So, from the strategic autonomy perspective, these are some of the dimensions. I am sure there are many more that we will realise, but, these would be top of mind.

The problem seems to be stark on the current account deficit front. Your projections show a significant jump. How do you see that situation playing out for India in this scenario?

In the near-term, the external sector still looks challenging because we have the impact of high oil price on the current account dynamics. And in India’s case, since we have not passed on the pump price increase to consumers, the elasticity of consumer demand is relatively inelastic. So, you have higher demand plus you have the higher cost of import because of the price effect. The typical sensitivity is every 10% increase in oil price worsens the current account deficit by about 0.4% of GDP. So, if we continue to average at $100 per barrel, then we are looking at 2% or higher as a percentage of GDP in terms of the current account deficit.

Now, again, is this a three-month thing or is this for six months? We don’t know, but at least, in the near term where the Strait of Hormuz is still blocked and you have both the price and the volume shocks still in the pipeline, this is a near-term risk on the current account. Plus, energy price shock has a differentiated impact globally. So, for a lot of Asian countries which actually sourced their energy from the Middle East and which are actually net energy importers, this is sort of a major negative terms of trade shock. But if you think about the US, which is now a net energy exporter and while US consumers will be adversely impacted because gasoline prices are high, the share of energy that is spent on overall consumption in the US is relatively small. Whereas, a lot of the business investment that is geared towards energy, will see an increase in investment and, the rest of the world which is unable to get oil or gas and particularly gas from the Middle East, will be looking at Australia, the US as the alternatives. So, the US actually ends up being relatively more insulated in this kind of an environment.

The reason it matters is because this actually leads to a stronger dollar. And, so for an emerging market, you’re facing not just an oil price shock, you are also facing the shock because of tighter global financial conditions that are getting triggered because of a stronger dollar. So, the impact on India’s capital account because of the foreign portfolio outflows is exaggerating this impact. A lot of this is particularly maybe a bit more severe in the next 2-3 months, beyond which, it depends on how this plays out. So if the shock recedes, then it is possible that focus will come back to how India’s growth is as compared to the last 12 months, where we had actually seen a sharp decline in the nominal GDP growth that actually you’re seeing a pickup in nominal GDP growth. There is actually a demand acceleration. So, things can change in a few months’ time even on the external sector. But for now, it does look like the dual impact on current account and capital account, will mean rupee is going to be the shock absorber at the margin.

How do you see China, its domestic slowdown… are things becoming tough for it?

I think the China view is more nuanced, in the sense that there’s a clear bifurcation between the domestic side of China versus the export engine of China. So even as the property market and domestic consumption remains very weak and we think will be weak at least in the first half of this year, the export engine of China is still running very fast and even as China’s exports to the US did come down, China’s exports to the rest of the world have actually moved up. And, the overall global export market share of China across a whole range of product categories has gone up.

China is also changing, it’s still one of the biggest export markets, like China’s export market share is 60-65% of global toy exports. In most product categories, we are talking about 25% or 40% global export market share, so it’s actually still doing very, very well. In the overall cost of doing business, the quality of products and just the quantity that China can produce is very difficult for many countries to actually replicate that model. China itself has actually over the last 10 years because of the trade frictions, been moving investments into a lot of the Southeast Asian countries like Vietnam, Thailand.

So, there are a lot of Chinese manufacturers who have invested in manufacturing facilities in these countries. While China is moving up the value chain, so in autos, in EVs, in particular, China has come up so substantially that this is now a threat to the German car industry or the Korean car industry. Simultaneously, in the tech scheme of things, where we have two ecosystems — US-based vis-à-vis the China-based — the investment on the tech side, the AI side ecosystem in China has been actually quite impressive. I think this view on China has to be more nuanced. Yes, there is the domestic side, which is weak, but there are these expert engines and the technology side actually, which is doing very well and China is moving up the value chain.

Are there opportunities for India, is the China plus one strategy working?

So, is China’s slowdown an opportunity for India? I think yes and no. The big theme has really been AI and tech in recent years and within Asia, the hardware manufacturers, like South Korea and Taiwan have done extremely well because they are benefitting from the increased demand for high-end chips and higher memory prices. But China is also benefiting because of its own investment in this ecosystem. At least in 2025 one of the disappointments for investors was that India was not actually present in some of these AI, tech-related themes. So even though China domestically was weak, India was not benefiting. Now, to your question of China plus one, I think this is very much still a major opportunity for India because we are talking about, 20%, 30%, 40% global export market share that China currently holds. And, in comparison, our export market share is less. So even if 2-3 percentage points of some of these product categories, India can replicate the success of what we have seen in Apple smartphone assembly in some of the other sectors, then it can be a very important game changer for India in terms of our export market share, manufacturing, job creation. So, these sectors we are looking at are the entire cluster of electronics manufacturing, textiles, leather, furniture, toys — the entire spectrum of manufacturing.

Now, it is important to recognise that China is a very important player in global manufacturing. Because the share of China in intermediate products is very high. So you cannot integrate into a global value chain without China because a lot of the intermediate products are getting produced in China. So, it will take time for any country to create its own domestic value chain, and become independent, it’ll take multiple years. Whether it’s electronics or its other product categories, there will be some dependence on China on intermediate products. So, it is a macro environment where, yes, there is an opportunity, because global MNCs themselves are looking to diversify risk, so it is something we are going to benefit from, but this requires some amount of integration with China for the components, where China is basically, the sole manufacturer. Over a period of time, we need to increase the domestic value add and move up the value chain. But creating that local ecosystem will obviously take time.

How do you look at India vis-à-vis global developments in AI?

That is one of the big questions which I think we’ll get back to once the Iran issue is out of the way. There are different parts of the AI value chain, where different countries are benefiting. You have the likes of Korea, Taiwan which are more at the hardware side of manufacturing. I think where India can benefit and should benefit in the coming years is in the data centre construction. The number of announcements we have seen in terms of data centre investments in India seems pretty impressive. As the execution of that begins, we should start to see some impact from data centre construction actually to India’s GDP growth, so I think that would be one part of the AI supply chain, where India is likely to benefit.

Second, even in the application of AI, I think Indians are very smart when it comes to applying things and where we will finally apply AI, it could create new business models, which it’s very hard to predict right now. But I think application of AI would be another segment where I see a lot of potential for young bright minds to actually apply and create a new business model going forward. So, those two primarily for now, and over a period of time, like manufacturing of certain components in advance testing, processing, some of the component manufacturing is where also India could benefit from this entire AI story. We did not benefit in the initial round but I think there is clear recognition that this is going to be one of the big growth drivers in the next many, many years and therefore, we need to know where we can take advantage. So, I am hoping for and expecting some of these benefits to through.

Now, the impact of AI on IT services is again extremely important and the initial sense, in terms of the impact, is at least in the near term, it does put pressure on margins for Indian IT companies. But from a more medium-term perspective, it could also open up for these companies a new set of revenue as clients globally shift from purely investing in maintenance tech to more innovative and innovation kind of tech, which could actually be a higher margin business over a period of time. A lot of the Indian IT services are also cognisant of these as a challenge and as an opportunity, and so the short term looks maybe a bit more negative from a margin perspective but over a period of time, I think businesses that adopt can actually take advantage of this huge business pool that will actually come through.

From a more macro perspective, businesses live in an environment, where there is a constant churn and you have to innovate to survive. So this is not the first change, we’ve been through multiple such cycles. There will be some companies who don’t benefit because they’re not making the change and then there will be others that make the change, get market share and will survive. So, businesses will do fine. But the question is what happens to jobs? Because if you can now do the same or more work with less number of people, then the number of jobs that get created will be less. So, you will still be okay in terms of overall revenue pool and profit pool over a period of time but the number of people you need might be 5-10% lower. So, it also becomes a jobs issue that we need to essentially figure out.

Going back to the energy part by asking how much scope does the government have for a fuel tax cut. Is this the right moment or will it be a great fiscal burden?

If we look at the special additional excise duty that India is collecting on petrol and diesel, it’s roughly Rs 13 per litre and Rs 10 per litre on these products. So that’s the sort of the extent of excise duty reduction that the Centre can make if it wants to protect the OMCs. Now this will come at a cost. Every Rs 2 per litre reduction in petrol and diesel excise lowers the Centre’s excise tax collections by about 0.1% of the GDP. So, if you announce, for instance, a Rs 6 reduction in excise tax on petrol and diesel, then you’re talking about 0.3% of GDP in terms of the fiscal impact.

And it’s not just excise, there is also the fertiliser subsidy that will go up because the cost of importing urea is moving up. So there’s also some upward pressure likely on fertilisers. Right now, based on where things are, our assessment is the additional burden on the Centre because of higher fuel and fertiliser subsidy plus a potential reduction in excise tax could be around 0.5% of GDP in terms of any fiscal burden that might come through. And, then of course, we’ll need to discuss how do we want to address this? Do we cut somewhere else, or do we raise money somewhere else, but that’s roughly the burden.

How do you view private sector investment? Will it pick steam?

I mean, we’ve been through multiple episodes like balance sheet correction and then one crisis after the other. I think the balance sheet issues are now clearly sorted out and the uncertainty is here. Like, if we are waiting for a perfect, smooth road ahead, I don’t think we will get it. So, the business model needs to work under the assumption that things are going to be uncertain. Private investment, the nature of private investment, will be different now because the world 20 years back was very different. It was more driven by, let’s say, thermal power generation. Today, you will see more renewable investments or nuclear power plants coming up. There is greater demand for defence equipment production, where the private sector has to participate. There’s actually a lot of opportunity for that as an export opportunity as well globally, which some of the companies are already catering to. The new sectors where we are trying to integrate on the global value chain, the electronics, smartphones are one component, but this is step one in the bigger plan of increasing domestic value addition and creating more upstream manufacturing capabilities across the value chain and replicating the smartphone success in other manufacturing sectors. So, the investments will basically need to come through in those sectors. Data centre investment, very, very capex heavy — that’s going to be an important driver. Behind the data centre investment is a lot of construction that needs to go on, requires energy inputs, that is where the investments will come in. So, I think the nature of investments will be very, very different to what we have seen previously. And we are in a world where there is excess capacity in a number of cyclical sectors like, petrochemicals, chemicals, and China in particular has been a big disinflationary force in the last few years, so it’ll need to be in some of the other sectors in my view.