What Lies Ahead For Indian Rupee In Higher Oil Price Environment

(MENAFN- ING) Oil shock resilience meets rupee strain

India's response to the latest oil shock raises three core questions: how well policymakers can shield growth and inflation, what's driving the rupee's sharp adjustment, and how long this strategy can hold if oil stays high. So far, the macro impact appears contained. Fuel subsidies have limited the immediate impact on inflation, while diversification of energy sources has helped address fuel shortages. But the pressure point has clearly shifted to the external side. The rupee has borne the brunt, not due to an outsized deterioration in the current account, but because of weaker capital inflows. Elevated wholesale price pressures, potential second-round effects on consumer inflation, and emerging energy supply constraints-particularly in coal-could complicate the outlook if global oil prices remain high for an extended period. Against this backdrop, we assess how India has navigated the shock so far and what the outlook implies for inflation, growth, and the currency.

How is India dealing with the oil shock, and what is the impact on prices?

India managed to shield consumers from the full impact of higher global oil prices by limiting the pass-through to retail fuel prices till mid-May. Gasoline and diesel prices have been raised 4 times in the last 10 days. Even so, gasoline prices have risen by only about 8%, making India one of the least affected economies in the region in terms of direct pump-price increases. As a result, the immediate impact on consumer price inflation has been relatively modest, estimated at around 20 basis points.

Yet underlying cost pressures are building rapidly at the wholesale level. WPI inflation more than doubled to 8.3% year-on-year in April 2026, up from 3.9% in March. Largely, this has been driven by a sharp 25% increase in fuel and metal prices. These pressures are beginning to broaden, with food inflation also showing signs of firming. Global rice prices have started to rise, while edible oil inflation remains elevated. The key risk ahead is that if elevated oil prices persist, upstream cost pressures will increasingly be passed through to consumers. That would push CPI higher and create upside risk to our still‐modest 2026 inflation forecast of 4.4%.

Low retail inflation in India-for now-as CPI risks catching up with WPI surge Source: CEIC

"> What has been the impact on growth?

Demand-side indicators suggest that overall economic activity remains resilient, albeit with some divergence across sectors. Non-oil, non-gold imports have remained strong, pointing to healthy underlying demand. Electronics imports surged by around 38% year-on-year, highlighting robust consumer demand. However, supply disruptions led to a sharp contraction in chemical imports, which could lead to demand destruction and impact growth.

Why India has managed the shock relatively well so far:

Lower oil intensity: The growth impact of higher oil prices has been cushioned by a structural decline in India's oil intensity over time. Oil imports as a share of GDP have fallen significantly from around 8.8% in 2013 to 4.8% last year, reflecting the faster expansion of the services sector vs industry. This has reduced the economy's vulnerability to external oil price shocks and helped limit the drag on growth. There is evidence of partial energy substitution. This is particularly true of coal in power generation. This shift reduced reliance on oil, although supply-side challenges are emerging. Coal production declined by 9.7% year-on-year in April, raising concerns about the ability to meet rising energy demand. Meanwhile, petroleum consumption has fallen by around 5%, suggesting some degree of demand adjustment in response to higher prices. Structural changes are also gradually reducing dependence on oil. The expansion of metro train networks and the increasing use of compressed natural gas and EV infrastructure are contributing to a slow but steady transition. These shifts aren't yet large enough to meaningfully curb oil demand, but they point in the right direction and should gradually reduce vulnerability over time. On the supply side, India has demonstrated considerable flexibility by diversifying its crude sourcing. According to Kpler, India's crude imports stabilised at around 4.5mn b/d in March and April, down from 5.2mn b/d in February, before rising modestly to 4.7mn b/d in May. Russian crude continued to dominate the import mix. This was supported by a US waiver allowing purchases of Russian cargoes loaded before 17 April and delivered by 16 May, even where the sellers or vessels involved were under US sanctions. Lower oil intensity has helped India manage the oil shock better Source: CEIC

"> The currency has taken the biggest hit. What changed?

The biggest impact of higher global oil prices has been on the currency. This shift is less about an exceptionally large current account deficit and more about flows. While India's external position is softening, it is far from crisis territory. We expect the current account deficit to widen to around 2.1% of GDP in 2026, up from around 0.5% in 2025, largely due to higher oil prices. Even with Brent averaging $104/bbl in 3Q , our CAD forecast of around 2% of GDP remains well below levels seen during past stress episodes such as the taper tantrum in 2013, where the current account deficit averaged over 4% of GDP. Yet, the extent of INR depreciation has been unusually large, reflecting weak capital inflows rather than current account imbalances.

Weak capital inflows behind external weakness Source: CEIC

"> Have equity market valuations corrected enough?

India has consistently traded at a significant premium to the broader EM universe for the last 5 years. The SENSEX P/E has ranged broadly between roughly 20x–33x, while MSCI EM has traded in a tighter band of roughly 11x–20x. India's long-standing premium to EM has compressed sharply since early 2026, driven by both EM re-rating and India's own de-rating from elevated post-Covid levels. Currently, India trades at approximately 21x trailing P/E vs. MSCI EM at about 18x, notably narrower than the peak spread seen in 2021–2022

Even after the recent correction in India's equity markets, driven by rupee weakness and higher crude prices, valuations still look stretched on a forward basis. Consensus expects India EPS growth at 14.4% vs MSCI EM at 19.2%, which weakens the case for a wide premium for India and helps explain the continued moderation in FII inflows. While part of the premium is structural, reflecting stronger earnings quality and macro stability, the current level appears ahead of near-term fundamentals.

In this context, the currency weakness reflects valuation-driven capital outflows rather than macroeconomic stress, as markets recalibrate to a narrower growth-and-valuation gap, even as India's structural story remains intact.

Persistent FII outflows Source: CEIC

"> Can FDI offset the drag from portfolio outflows?

Only partially. India has undoubtedly benefited from supply chain diversification, emerging as a key FDI destination in the region, particularly in electronics manufacturing and digital services. Gross FDI inflows have remained relatively stable, at around $21bn in 2025, broadly unchanged from the previous year.

However, this stability in gross flows masks a sharp deterioration in net FDI. Since 2022, inflows have weakened due to two offsetting dynamics. First, repatriation by foreign investors has increased sharply, roughly doubling over the past four years. With US interest rates elevated and global uncertainty high, multinational parents increasingly repatriated earnings or redeployed capital to higher-return markets, reducing reinvestment in India

Second, outward FDI by Indian firms has nearly doubled, reflecting increasing globalisation of domestic corporates. Indian firms are increasingly allocating capital overseas, rather than reinvesting domestically.

As a result, even though net FDI rebounded in FY26 to $7.65bn from a multi-year low of around $1bn in FY25. The broader trend remains one of significant compression, with net inflows still down nearly 80% over the past four years.

The implication is that while India continues to attract structurally strong gross FDI, the net support to the balance of payments has diminished materially. This limits its ability to offset portfolio outflows and act as a stabilising force for the currency in the current environment.

Repatriation by foreign investors doubled over the past four years Outward FDI by Indian firms has also nearly doubled Source: CEIC

"> Can a USD deposit scheme support the Rupee?

India has a track record of using Non-Resident Indian (NRI) deposit schemes to attract foreign currency during periods of stress. The 2013 Foreign Currency Non-Resident (Bank) scheme remains the most successful example, raising roughly $25bn within a short window. Its success hinged on attractive returns effectively hedged against currency risk, making it compelling for depositors and quickly boosting FX inflows.

Replicating that success today is more challenging. With an annual balance-of-payments gap of around $70bn, any new scheme would need to offer meaningfully attractive pricing to achieve scale. However, the global rate environment is very different. In 2013, US Federal Reserve rates were near zero. Today, they're closer to 3.75%, significantly increasing the cost of mobilising foreign-currency deposits, particularly if currency risk is absorbed centrally.

At the same time, India's external buffers are much stronger than in 2013. FX reserves have expanded by roughly 2.5x, giving the Reserve Bank of India (RBI) greater firepower to manage volatility without resorting to aggressive external fundraising.

In this context, while a USD deposit scheme could provide a tactical boost to FX liquidity and market sentiment, the bar for success is higher, costs are steeper, and the need is less acute given stronger reserve buffers.

How does INR fare on valuation?

The REER appreciated steadily from early 2023 to peak in November 2024, driven by a relatively stable USD/INR even as India's inflation ran persistently above that of its key trading partners. This combination pushed the rupee into meaningfully overvalued territory in real terms.

Since then, however, the adjustment has been swift. The CPI inflation rate has nearly halved to an average 2.5%. The REER has declined by over 12%, bringing it back to levels last seen around 2014. On a broader valuation lens, the INR now sits near the bottom of its six-year REER range, indicating that much of the earlier overvaluation has been unwound.

In a cross-EM context, this correction stands out. While currencies such as the Indonesian rupiah (IDR) and Philippine peso (PHP) have seen sizeable nominal depreciation, their REER levels remain relatively higher. This reflects more persistent structural inflationary pressures and weaker macroeconomic dynamics. By comparison, the INR now appears less stretched on a real basis, suggesting that valuation is no longer a key headwind-and may even begin to offer some support at the margin.

India's real effective exchange rate has fallen materially Source: CEIC

"> Overall

The INR is facing a sizeable balance-of-payments deficit. Despite relatively strong macroeconomic fundamentals, structural import dependence continues to bias the currency lower. The outlook for portfolio flows remains mixed. Equity inflows are likely to remain subdued for now. Valuations, though off their peaks, still look relatively elevated and may need more time to draw sustained foreign interest.

In contrast, debt inflows should gradually turn more supportive, underpinned by stable fiscal dynamics and an improving inflation trajectory. At the same time, a combination of RBI FX management and the recent correction in REER-bringing the INR closer to undervalued levels-should help limit further downside.

Overall, while near-term pressures persist, the adjustment is already well underway. We expect USD/INR to end the year at 95.50, with risks skewed more towards gradual stabilisation than a disorderly weakening.

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