With no end in sight to the West Asia war, concerns are rising over inflation, interest rates and GDP growth in India. As part of the Money Guru series, Bank of Baroda chief economist Madan Sabnavis breaks down the potential impact on the economy, household finances and job markets, and assesses whether recession risks are real or overstated.
Inflation in India has been relatively benign. What impact could the West Asia war and energy crisis have on everyday inflation, especially food and fuel prices?
At a theoretical level, inflation could rise, but much depends on how long the war lasts, how high crude oil prices go and how much of this increase is passed on to consumers. So far, the government reduced excise duty on petrol and diesel, absorbing much of the crude price increase. The key question is how long this can continue.
If crude oil prices return to $80-90 per barrel, there may not be a major issue. But if prices stay above $100 for a couple of months, the government may eventually raise fuel prices. This could increase the Wholesale Price Index by around 2-3% and the Consumer Price Index (CPI) by about 0.5%.
Indirect effects could be more significant. LPG availability, rising fertiliser costs and higher gas prices could push up inflation across petroleum products. Overall, CPI inflation could rise by 0.5-1% if the war continues for 3-6 months and costs are passed on to consumers.
If the war lasts six to eight months or longer, what risks are households underestimating?
Households may be underestimating the persistence of higher inflation. Instead of staying around 2.5-3%, inflation could rise to 4.5-5%. Perceived inflation is typically 2-3 percentage points higher, meaning households could feel inflation closer to 7%.
This affects budgeting decisions like how much to spend versus save. With rising prices across food, consumer durables and FMCG goods, consumption will increase, leaving less room for savings. This trade-off between consumption and savings could have broader economic implications as both are needed for growth.
Has the ongoing situation impacted household borrowing decisions such as home or auto loans?
Not significantly so far. Also, because these are long-term, planned expenses—home loans span 15-20 years and vehicle loans about five years. There’s no strong reason for households to delay such decisions due to the war.
In fact, there may be an incentive to purchase sooner to lock in current prices as inflation fears could push prices in the future.
Gold loans grew strongly last year. With gold prices cooling, is there any stress in this segment?
As of now, no stress has been reported by banks or NBFCs. Besides, it’s important to distinguish between falling gold prices and borrower repayment capacity.
Banks typically lend to existing customers with known credit histories and loans are given with a loan-to-value ratio. A decline in collateral value does not automatically imply asset quality deterioration. Stress typically emerges when borrowers lose income, not merely due to price movements in gold.
What is your expectation from the Reserve Bank of India’s upcoming monetary policy meeting?
The RBI is likely to adopt a wait-and-watch approach. Current inflation is around 3%, though it may rise above 4%. The central bank will remain cautious and signal readiness to act if needed.
Given the uncertainty, especially around the duration of the war and crude oil prices, it is unlikely that the RBI will change the repo rate or its stance immediately.
What would this mean for consumer loans and EMIs over the next 12-24 months?
Even with the wait-and-watch approach, the rate cut cycle appears to have ended, with the repo rate at 5.25% likely being the lowest point. Future movements, if any, are more likely to be upward.
Markets indicate a possible increase of up to 75 basis points, though realistically, at least one rate hike could occur this year. The repo rate could reach around 5.5% by December. Factors like the monsoon and potential El Niño conditions will also play a role, besides the war.
Why is the transmission of rate cuts slower than rate hikes for borrowers?
Transmission depends on the lending framework. Loans linked to the external benchmark lending rate (EBLR) adjust automatically with repo rate changes. However, banks also add spreads, which can vary. So, if the spread is increasing, it could give the impression that the transmission is not taking place.
Besides, around 40% of loans are still linked to the marginal cost of funds-based lending rate (MCLR), which depends on deposit rates. If deposit rates don’t fall proportionately, lending rates don’t either. This creates the perception of incomplete transmission.
If the world economy is deeply impacted with a prolonged war, is India at risk of a recession?
No. A recession implies negative GDP growth for two consecutive quarters, which is not the case for India. Even in a worst-case scenario, GDP growth may slow to around 7%, compared to 7.2-7.25% currently projected.
A slowdown is possible if inflation rises and affects consumption and investment, but that is very different from a recession.
Bernstein estimates the rupee will weaken to 98 per dollar if the war prolongs for another month and worsen to 110 if it continues through 2026. What can households do to protect their purchasing power?
Households are essentially price takers in foreign exchange markets and cannot hedge currency risk like corporates. The only adjustments possible are behavioral, including cutting travel budgets or managing education expenses abroad.
Also, my view is that the rupee may settle around 95 per dollar. Much of the depreciation is due to a strong US dollar. If the dollar weakens, other currencies, including the rupee, may stabilize.
What can people expect from the job market and appraisals in the coming year? Should young professionals rethink career planning?
The job market should remain stable, as it is linked to GDP growth, which is expected to stay around 7-7.5%. However, sectoral differences will exist.
Export-oriented sectors may face pressure, while the technology sector presents both challenges and opportunities, especially with AI. Hiring trends in IT appear more positive than negative.
Young professionals may face modest starting salaries, but opportunities will remain available for those with the right skills.