Why West Asia war didn’t hurt India economy as much as was feared

Chart 1: GDP growth rate

Making matters worse was the threat of high temperatures thanks to the El Niño phenomenon that threatened to hit food production and drive up inflation.

The growth rate was expected to fall below 7% (many even predicted a rate closer to 6%). The inflation rate was expected to skyrocket from  2% (in 2025-26) to somewhere near 6% — in other words, from the lower end of RBI’s “comfort zone” to the upper limit.

Chart 2: Inflation rate

A key moment came on May 11 when Prime Minister Narendra Modi appealed to Indians to tighten their belts by stopping purchases of gold, reducing consumption of fuel, working from home and using public transport, among other measures.

But six months since the start of the war, the macroeconomic data shows that India hasn’t fared as poorly as feared. Is this a return to what analysts earlier this year called a “Goldilocks” situation?

Resilient economy or an incomplete picture?

Six months since the start of the war, while there have been many disruptions, the GDP growth rate, inflation rate, and current account balance do not show the kind of impairment that was initially feared. The current account balance maps India’s trade in goods and services with the rest of the world, and the consequent flow of money.

A research note from HSBC states: “Growth remains high, inflation remains low, and the current account deficit surprisingly contained. Headline numbers across the board feel more goldilocks than crisis.”

“Goldilocks” was a term analysts were using at the start of the year to describe the optimal state of affairs in India’s economy. The term, however, quickly lost favour once the West Asia war exposed the more persistent weaknesses in the economy — best captured by the sharp fall in the rupee’s exchange rate.

As such, it makes sense to carefully examine whether the Indian economy has genuinely gone back to a “Goldilocks” scenario or the benign macroeconomic data hides significant risks.

In a detailed note, HSBC economists led by Pranjul Bhandari have explained both scenarios — why India’s macros did not worsen as much as was expected, and what are the triggers that may yet make the picture worse.

On GDP growth

In a recent note, researchers at Centre for Monitoring Indian Economy (CMIE) also noted that “India is expected to have sailed through the June 2026 quarter better than feared”.

Notwithstanding the worst of the energy crisis during the first quarter (April, May and June) of the current financial year, HSBC’s 100-indicators of growth database points towards India’s GDP growing by 7-7.5% during this period. State Bank of India’s research team has gone a step further, projecting an 8% growth in GDP in the first three months of the current financial year (2026-27).

So what are the factors behind this economic resilience?

Some of it can be ascribed to the 125-basis point (or 1.25 percentage points) cut in the repo rate between December 2024 and December 2025 (see chart 3).

Chart 3: repo rate

Repo rate is the interest rate at which the RBI lends money to commercial banks in India. When the RBI cuts the repo rate, it makes it cheaper for banks to borrow money from the RBI and, in turn, cheaper for individuals and businesses to borrow money from commercial banks. Cheaper loans incentivise economic activity in the economy, thus boosting growth.

Often the “transmission” of repo rate cut takes a couple of quarters (six months) before it starts showing up as a faster GDP growth rate.

Another factor could be the effect of cuts in Goods and Services Tax in 2025. Lower tax rates reduced prices and improved people’s purchasing power, thus resulting in more purchases and higher economic activity. Yet another factor noted by HSBC economists is the rise of India’s exports to the US as Donald Trump’s tariffs were removed. Lastly, there is evidence to suggest that manufacturers front-loaded production as they were anxious about even the availability of energy in the future.

On inflation

While it is true that monthly retail inflation rate — or the rate at which the general price level went up over the past year — has moved up since October 2025, it is also true that overall, it is still well-contained and pretty close to the RBI’s target level of 4% (see chart 4). Many, including HSBC, had feared inflation to surge to far more uncomfortable levels.

Chart 4: Monthly inflation

Often, inflation remains muted because growth is muted but as explained before, this doesn’t seem to have been the case. Inflation has remained muted despite supply pressures as well demand holding up fairly well.

The current account balance

Current account refers to the net amount of money flowing in or out of India as it trades (exports and imports) goods as well as services with the rest of the world.

Typically, when India is growing fast as well as when imports (such as crude oil) are getting costlier, the country imports more goods than it exports, thus leading to what is called a trade deficit. It refers to the billions of dollars flowing out of India as it spends more dollars on imports than what it earns through exports.

Further, more often than not, what India earns from exports of services (like software services) as well as from the remittances from Indians working abroad, is not enough to cover the dollars India shells out for imports of goods (over and above what it earns from exports). The net result is called a Current Account Deficit.

But despite fast growth and costlier imports, India’s Current Account Deficit too has remained fairly muted.

“The headline c/a deficit is low at 0.3% of GDP as per RBI’s aggregated monthly data, and not showing signs of excesses,” notes the HSBC economists (see chart 5).

Chart 5: Current account balance

Could things be read differently?

Yes. While on the face of it, all these macro indicators look counter-intuitively robust, there are risks that can yet drag down growth and push up inflation. Here’s how.

On growth, HSBC researchers state that a lot of the credit growth (increased loans) has been driven by factors such as “the new government credit guarantee scheme for small firms, the rise in working capital needs spurred by higher commodity prices, and the proliferation of gold loan growth (which can sometimes be seen as an indicator of stress).”

Moreover, it can also be argued that “while frontloading of manufacturing has spurred it can be followed by a lull”. Moreover, agricultural growth could be weaker if the El Niño strengthens into the year-end.

On inflation, as Chart 6 shows, the overall benign level of inflation rate hides fairly divergent trends. HSBC Research stated that food inflation and non-food goods inflation is already averaging 5.4% (year-on-year) in July.

Chart 6: Inflation breakup

What is holding back the headline inflation from surging is that services (which account for 33% of the weight in retail inflation calculations) has remained “remarkably low at 2.5%”. And therein lies the risk.

“Low services inflation data is keeping headline (rate) contained. If it rises from here, reflecting growth better, headline inflation numbers could rise quickly,” notes HSBC.

Similarly, on current account deficit, a closer look at Chart 5 shows that the current account deficit is low as of now because even though the goods trade deficit is growing, rising services exports and remittances are offsetting the rise in trade deficit”, thus keeping the current account deficit low.

HSBC wonders what will happen if this luck runs out.

“But given the uncertainties around the impact of AI on services exports growth, one needs to be careful on how long services can fund a rising goods deficit. Already, services exports have grown at a softer pace this year,” notes HSBC.

Upshot

Few expected India to survive this phase of global disruption without taking a big hit. HSBC researchers argue that it is the services sector that is saving India the blushes as of now.

It is a fact that the services sector which accounts for 55% of India’s GDP plays a very important role in determining where growth will land, how long inflation will remain low, and till when will external deficits be contained.

“Low services inflation and high services exports are keeping a lid on inflation and external imbalances, respectively,” states HSBC.

If services inflation goes up and services exports take a hit, the RBI may be forced to raise interest rates, which, in turn, will likely dampen India’s growth.