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Despite Brent retracing ~25% from its peak on hopes of a US-Iran deal, underlying oil market conditions remain tight. The key variable is inventory depletion; global inventories could approach critical levels by late-Jun/early-Jul-26, risking renewed price spikes unless SoH flows normalize. Even then, geopolitical risks, logistics frictions, and inventory rebuilding may keep prices elevated. Temporary buffers—including SPR releases, OECD/China inventory draws, refinery run cuts, and demand substitution—have so far contained prices. We raise our FY27E average Brent assumption to USD90/bbl (from USD80/bbl), before easing to USD75/bbl by Q4FY27E. Combined with El Niño risks, we trim FY27E GDP growth to 6.3% and maintain inflation at 5.1%. We view a broadly equal sharing of the oil shock across OMCs, government, and consumers as the least growthdamaging outcome, with net fiscal cost tracking ~0.2–0.3% of GDP. The bigger vulnerability lies in the external sector. We now expect CAD/GDP to widen to 2.3%, while FY27E BoP deficit could exceed USD75bn, absent credible measures to attract foreign capital. Policy trade-offs will increasingly revolve around inflation, growth, FX stability, and capital flows, with RBI likely using rates to anchor inflation rather than defend INR.

Oil realities are muddier; expect price stickiness amid physical imbalances

Hopes of a potential US-Iran agreement have pulled Brent prices back by ~25% from the crisis peak of USD125/bbl. However, we maintain that Iran has limited incentive to fully reopen SoH, absent a broader geopolitical settlement. Accordingly, our focus has shifted from headline-driven expectations around reopening toward the underlying physical balance of the oil market. In our view, it is ultimately the pace of inventory depletion that will determine when the market is forced into resolution. Our assessment suggests that by late-Jun/early-Jul-26, global inventories could fall toward critical threshold levels, materially tightening available energy buffers. Unless SoH throughput returns to pre-conflict levels, oil prices could reprice sharply higher. While similar concerns have surfaced throughout this conflict, there are buffers which have kept oil prices relatively contained, including i) US draining its SPR, and inventory draws more generally by OECD/China; ii) refinery run cuts; iii) the role of China in adding supply; and iv) substitution/demand reduction. Our core assumption is that accelerating inventory depletion will eventually force a normalization of SoH flows by endJun/early-Jul-26—gradually adjusting fundamental balances. Even then, price normalization may lag, as geopolitical risks, logistics friction, and the need to rebuild inventories keep premiums elevated, notwithstanding incremental supply from Iran and a lagged shale response.

FY27E growth trimmed to 6.3%; BoP risks outweigh stagflation concerns

We raise our FY27E Brent assumption to USD90/bbl (from USD80/bbl earlier), reflecting tighter markets in Q2 before easing to USD75/bbl by Q4. Combined with El Niño-related monsoon risks, we trim our FY27 GDP growth forecast by 30bps to 6.3%, though GVA growth should remain higher at 6.5% amid lower net indirect taxes. We forecast FY27 inflation at 5.1%, incorporating moderate El Niño, a Rs10/ltr fuel price hike in Q1FY27 (partly reversed by Q4 as oil falls sub-USD80/bbl), and second-round energy spillovers. Ultimately, the macro impact will depend on how the crude shock is shared between OMCs, government, and end-consumers. In a sustained high-oil-price scenario, we believe the least growth-damaging outcome would be a (near) equal pass-through among all economic agents. We think OMCs will be allowed to rebuild margins as oil prices correct later, while net fiscal hit is likely to be ~0.2-0.3% of GDP. While FY27 CAD/GDP may now widen to 2.3% of GDP (1.7% at Brent USD80/bbl), the bigger vulnerability lies in the capital account. Absent regulatory policy measures to attract foreign inflows, FY27 could see a BoP deficit of >USD75bn

Policy choices unlikely to be easy:

FX-rate trade-offs and long-term energy security There is no simple playbook for policy responses to the energy price shock. As the pass-through of elevated energy costs to consumers is now underway, second-round effects via inflation expectations, growth shocks, tighter financial conditions, and FX management shape RBI’s trade-offs. Any future rate hike would be aimed at curbing domestic demand pressures or anchoring inflation expectations, rather than defending INR. FX volatility will continue to be managed through reserves and regulatory measures. More broadly, policymakers have tended to prioritize growth-inflation objectives over FX stability over the year(s), keeping rates relatively accommodative despite periods of external outflows. While this may have made FX arbitrage/speculative INR trades cheaper, higher rates alone may not attract durable capital flows that eventually follow credible growth and sectoral innovations. Separately, from an energy security point of view, there is a case to use fuel taxation strategically and avoid broad-based fuel subsidies to encourage i) efficiency and lower oil intensity; ii) energy security; iii) push diversification toward EVs, public transport, and renewables; and iv) fiscal health. The additional fiscal revenue space can be used to reallocate resources directly to the vulnerable section of the economy that may feel disproportionately hit from higher taxes.

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