Dipak Kurmi
In the contemporary global landscape, economic uncertainty has undergone a profound transformation, hardening from a periodic or transient disturbance into a permanent and defining macroeconomic condition. For the Indian economy, this volatility is no longer merely an external backdrop or a distant ripple; it has become a pervasive set of forces actively shaping domestic monetary policy, fiscal arithmetic, and the delicate architecture of intergovernmental relations. The Reserve Bank of India (RBI) and the Ministry of Finance find themselves at a critical juncture, navigating a world where energy price volatility, sharpening geopolitical tensions, sudden capital flow reversals, and chronic supply disruptions interact in persistent and complex ways. These external pressures are increasingly transmitted through India’s intricate federal structure, exposing state governments to global shocks without providing them with the commensurate policy flexibility or revenue autonomy required to buffer such impacts.
The Reserve Bank of India’s strategic decision to hold the policy repo rate at 5.25 per cent reflects a highly calibrated pause rather than a sign of institutional inertia. Following an unusually benign inflationary phase in 2025, price levels are now normalizing toward the 4.5–4.7 per cent range, yet the risks to this stability are clearly tilted upward. With Brent crude oil prices crossing the psychological and economic threshold of $100 per barrel, imported inflation pressures have been reintroduced with vigor, primarily through the heightened costs of fuel, fertilizers, and essential transport. Inflationary expectations, particularly those driven by the volatile food and energy components, remain acutely sensitive to these external shocks. This creates a sharp dilemma for the central bank: easing the monetary stance too early risks unanchoring long-term expectations, while further tightening could inadvertently compress a domestic recovery that is already showing signs of losing momentum.
Further complicating this precarious domestic balance is the aggressive policy stance adopted by the United States Federal Reserve. Policy signals from the Fed chair have consistently reinforced a higher-for-longer interest rate environment, which has served to strengthen the US dollar and tighten global liquidity. For India, this international environment translates into intermittent capital outflows and sustained exchange rate pressures, as episodes of capital flight—particularly from the debt markets—intensify in response to shifting expectations about American interest rates. The Indian rupee, though historically resilient compared to its emerging market peers, has faced significant depreciation pressures. This reflects both the global strength of the dollar and a widening trade deficit driven by the surging costs of energy imports, creating a feedback loop that challenges domestic stability.
Currency depreciation serves as a direct transmission mechanism for inflation by raising the landing cost of imports, most notably crude oil, which is the lifeblood of the Indian economy. This phenomenon also complicates the process of monetary transmission, as the RBI must manage a dual mandate: ensuring domestic price stability while simultaneously safeguarding external stability. Managing these twin concerns often requires liquidity adjustments that may not necessarily align with domestic growth conditions, making policy calibration an increasingly complex task in a volatile global environment. As a result, the central bank must act as both a domestic anchor and a global shock absorber, balancing the need for growth with the imperative of protecting the currency’s value and the nation’s foreign exchange reserves.
Economic growth, while still robust by global standards, is beginning to show signs of moderation under the weight of these layered pressures. After expanding at an impressive rate of approximately 7.5 per cent in FY26, India’s GDP growth is expected to ease towards the 6.8–7.2 per cent range in the coming cycles. External demand is weakening as global trade slows, financial conditions are tightening both domestically and internationally, and domestic consumption remains vulnerable to the persistent threat of inflation shocks. Bond markets clearly reflect this atmosphere of uncertainty, as the term structure of interest rates has shown intermittent steepening. Long-term yields are increasingly embedding higher inflation expectations, anticipated fiscal borrowing pressures from the government, and elevated global risk premia, all of which reinforce the RBI’s cautious and vigilant stance.
On the fiscal side, the Union Government’s path toward consolidation remains a priority, with a targeted deficit of 4.3 per cent of GDP. While this goal remains credible, it is becoming increasingly contingent on favorable global assumptions that may not hold. Rising oil prices naturally widen the current account deficit and increase the government's subsidy burden for fuel and fertilizers, while slower global growth risks dampening tax buoyancy. At the same time, the government faces substantial and non-negotiable expenditure commitments toward infrastructure development, social welfare, and national defense. Public debt, which has remained elevated since the pandemic, significantly constrains fiscal flexibility. Furthermore, war-related uncertainties in various global theaters further complicate the fiscal arithmetic, both directly through the necessity of higher defense spending and indirectly through commodity price volatility.
A deeper and often less examined challenge in this scenario lies within India’s fiscal federal structure. State governments are responsible for a substantial share of total public spending, particularly in critical sectors such as health, education, and rural infrastructure, yet their fiscal capacity is severely constrained by limited revenue autonomy. In an environment defined by heightened global uncertainty, the states' dependence on transfers from the Centre becomes a significant source of instability. Intergovernmental transfers, especially those linked to shared taxes, are inherently volatile and fluctuate alongside economic cycles and central policy decisions. Any delays, shortfalls, or sudden changes in allocation formulas amplify fiscal uncertainty at the state level, leaving local administrations with little room to navigate economic downturns.
The cumulative result of these factors is a severe fiscal space crunch for the states. Local governments must meet committed expenditures, such as salaries, pensions, interest payments, and ongoing welfare programmes, even as their revenue streams fluctuate due to global factors beyond their control. Borrowing limits imposed by national fiscal responsibility frameworks further restrict their ability to respond countercyclically to economic shocks. This often leads to a forced compression of capital expenditure at the state level, which undermines long-term growth prospects for the entire nation. In effect, the Indian economy is witnessing a situation where macroeconomic stabilization is centralized at the Union level, while the resulting fiscal stress is decentralised and borne by the states.
Global shocks also amplify existing federal tensions between the Centre and the states. Rising energy prices increase the subsidy burdens across both Union and state budgets simultaneously. If the Centre chooses to absorb a larger share of these costs to protect the consumer, the pool of divisible taxes may shrink, thereby constraining transfers to the states. Conversely, if states are forced to bear more of the burden, their already fragile fiscal stress deepens. In either scenario, vital public investment risks being crowded out by the need to fund immediate consumption and subsidies. The interaction between global volatility and domestic fiscal arrangements thus creates a dangerous feedback loop that complicates the overall effectiveness of national economic policy.
Supply chain disruptions add yet another layer of complexity to the Indian macroeconomic narrative. Maritime chokepoints, such as the Strait of Hormuz and the Red Sea, have become increasingly fragile due to geopolitical strife, forcing the rerouting of global shipments via significantly longer routes like the Cape of Good Hope. For India, these disruptions raise freight costs, extend delivery times, and increase the uncertainty of international trade. This directly affects the competitiveness of Indian exports, reduces port efficiency, and escalates logistics costs for domestic manufacturers. Ports face increased congestion and scheduling disruptions, while industries that are heavily dependent on imported inputs encounter significant delays and cost escalations that threaten their profit margins and operational viability.
A less visible but equally critical vulnerability lies in India’s digital infrastructure. Submarine cables running along major maritime routes carry a significant share of global internet traffic and financial data. Any disruption in these corridors can have immediate and systemic implications for financial transactions, services exports, and the functioning of digital platforms. In an economy where digital services are a primary driver of growth and financial inclusion, such risks cannot be ignored. Furthermore, for small and medium enterprises, these layered uncertainties translate into much tighter financial conditions. Credit channels become more risk-averse, with lenders demanding higher risk premia that raise the effective borrowing costs for firms even in the absence of formal policy rate hikes.
What distinguishes the current economic phase from previous crises is its multiplicity and its persistence. Unlike the COVID-19 pandemic, which was a singular, albeit massive, global shock, today’s uncertainty is layered and multifaceted. Energy volatility, capital flow reversals, currency pressures, supply chain disruptions, and federal fiscal constraints are interacting simultaneously and reinforcing one another. These are no longer transient disturbances that will fade with time; they have become structural features of the modern global economy. For Indian policymakers, this reality requires a fundamental shift from reactive crisis management toward proactive resilience building. The RBI must preserve the hard-won credibility of its inflation-targeting framework while managing exchange rate stability, and the Ministry of Finance must pursue fiscal consolidation without stifling the investments necessary for future growth. Strengthening fiscal federalism by ensuring predictability in tax transfers and greater coordination between the Centre and states will be the ultimate test of India’s institutional adaptability.
(The writer can be reached at dipakkurmiglpltd@gmail.com)
