Policy Update
Anushree Khare
Background
When you look at India’s merchandise trade data for May 2026, there appears to be some contradictory information.
- India’s merchandise exports were at their highest level ever recorded; the growth in each segment was widespread and included almost all segments of the economy.
- However, the trade deficit widened by $3.7 billion over last year’s figure of $6.8 billion to reach $10.5 billion.
Even though India’s trade deficit grew, its exports actually hit a record high.
The events surrounding this month’s trade data are being impacted by the ongoing conflict in West Asia. This conflict caused disruptions to oil production and shipment via the Strait of Hormuz throughout much of 2026.
As a result of these disruptions, oil prices climbed above $120 per barrel during the peak of the conflict in April, then began to decrease again in June. These price swings were passed directly into India’s import bill due to India’s continuing heavy reliance on imported crude.
Therefore, when viewed within the context of India’s trade data for May, this represents a terms of trade shock (i.e., a shock resulting from changes in relative prices) and not a competitive issue. Two structural safeguards, a diversified export base and increasing services surplus allowed India’s external sector to absorb this shock without leading to a broader concern about India’s external sector.
Functioning
There is one route by which the effects of a regional conflict would impact India’s trade deficit: the pricing of crude oil.
Most of India’s crude requirements are met through imports, therefore any sustained increases in the international price of crude will flow automatically into India’s import costs regardless of whether the quantity of crude consumed by India is changing or if any other sectors have experienced positive or negative performance. That is exactly what happened in May 2026.
- The Indian Basket crude oil price increased by 65.9 percent over the prior year, and the value of imports of crude and petroleum products increased by 53.8 percent due to this increase.
- Even though non-energy imports also grew, energy price effects dominated, the overall growth rate of merchandise imports reached 20.6 percent as a result of this price transmission effect (Department of Economic Affairs, Economic Division, 2026).
Since the price transmission channel is independent of how well exports perform, it is possible for exports and the trade deficit to grow in opposite directions in the same month. Moreover, the mechanism works through a commodity price pass-through and not through shifts in trading volumes or terms of engagement with any specific markets, it is clear that the path of the trade deficit is closely tied to events in West Asia and the Strait of Hormuz and not to general questions regarding the competitiveness of Indian trade.
Furthermore, there was a second, policy-driven mechanism operating in opposition to the increase in precious metal imports. Imports of silver decreased 86.6 percent over the prior year and gold import growth slowed to 33.9 percent in May compared to 81.7 percent in April after duty hikes were imposed on both metals and additional types of silver imports were classified as restricted category imports illustrating how rapidly imports can respond when a policy lever is available.
Exports from India grew 15.8 percent year over year in May 2026 and reached a total of USD 82 billion compared to USD 70.8 billion in May 2025. Growth of goods exports outpaced growth of service exports with 18 percent versus 13.2 percent and touched a record monthly value of USD 45.2 billion (Ministry of Commerce and Industry and Department of Commerce, 2026).
Growth was not concentrated in just a few sectors:
- Exports without petroleum and without gems and jewelry made up 75.8 percent of total merchandise and grew 12.3 percent year on year.
- There were double digit growth rates for engineering goods, chemicals, electronics and meat, dairy and poultry products.
West Asia Disruption
Regional disruption from conflicts in West Asia was sharper among individual trading partners compared to aggregate figures.
- Exports to Iraq dropped 70.2 percent year over year and to Iran 58 percent.
- Exports to Kuwait fell by 50.6 percent and to Qatar by 49.6 percent as well.
- Imports from Iraq, Kuwait and Qatar fell by 93.7 percent, 96.4 percent and 82.9 percent respectively.
- Growth continued for exports to UAE and Saudi Arabia.
- There was expansion into Africa and ASEAN.
- Imports from Oman also rose sharply (up 305.7 percent) because ports at Sohar, Salalah and Duqm served as important logistics gateways when transit through strait was restricted.
The overall trade deficit widened but remained contained. Services exports rose to $36.8 billion in May 2026 from $32.5 billion from a year ago and the surplus in service trade expanded 12.3 percent year over year to $17.7 billion.
This surplus offset 62.7 percent of the deficit for that month (Reserve Bank of India, 2026) and kept the overall deficit at $10.5 billion rather than a much larger number.
This pattern is consistent with April 2026 balance of payments data where despite a larger deficit in goods trade, a current account surplus of $4.7 billion was recorded because of strength in exports of services and inflows of remittances. Exports stayed competitive even during the shock. What widened the deficit was price for a single large category of largely inelastic imports rather than deterioration in underlying trade position overall.
Impact
The distinctions between deficits are driven by price increases versus those by volume or competitiveness matters because they point to different outcomes and different responses.
A deficit driven by growth across categories of imports suggests either weakening competitiveness domestically or failure of substitution imports, which calls for structural correction. By contrast, a spike in oil prices transmits an external shock that fades as global energy prices return to normal and no change is needed in the underlying export sector.
Regional trade disruption also shows value in diversification that had already been underway prior to this crisis. Had India’s export and import relationships still been concentrated on West Asia as they were a decade ago, disruption to trade with Iraq, Iran, Kuwait and Qatar would likely show up in aggregate trade figures rather than being absorbed.
Instead, diversification of both destination markets and composition of exports gave external accounts the room to absorb this shock without a disproportionate deterioration in the already-worsening trade balance .
Emerging Concerns
There are two concerns that need continuous monitoring.
First of all, since the trade deficit has been sensitive to the price of oil, there are many variables at play with regards to where the path will go in terms of oil pricing and its impact upon trade going forward. Although the downward trend in Brent crude pricing throughout 2026 had provided some respite by June 2026, the U.S. Energy Information Administration reported in their June 2026 Outlook that an extended period of time is expected regarding the interruption of production due to geopolitical activity within West Asia than had previously been assessed.
Second, global trade volume growth is anticipated to slow down as well. The World Bank reports that global trade volume grew at a rate of 4.8 percent in 2025 and is now forecasted to grow at approximately 2.9 percent in 2026. This decrease is attributed to both the reduction of tariff-driven front loading as well as continued trade policy uncertainty. Despite a strong performance for India’s exports in May 2026 compared to other countries globally, a slowdown in global trade volume may hinder sustaining the diversification benefits recorded in 2026, especially with regard to merchandise exports which are subject to external demand versus internal consumption.
Way Ahead
Three main conclusions for policy consideration emerge based upon the May 2026 data.
- Firstly, the increase in the size of the trade deficit does not represent a decline in the country’s ability to compete in terms of export capabilities.
- Secondly, continuous and purposeful implementation of new trade agreements, including those that have recently entered into force (i.e., the India-Oman CEPA effective June 1, 2026, and the India-UK Comprehensive Economic and Trade Agreement effective July 15, 2026), and enhanced market access for agricultural and marine products within the EU.
- Lastly, the fact that services accounted for approximately 63% of the merchandise deficit suggests that continued support for service-based exports in addition to continued efforts in merchandise diversification, both of which were evident in May’s data.
References
About The Contributor
Anushree Khare is a Research & Editorial Intern at the Impact and Policy Research Institute (IMPRI). She holds a B.A (Hons) degree in Economics with Research. Her academic and professional interests lie in the domains of finance, quantitative research, data-driven policy analysis, and business strategy.
Acknowledgement
The author extends sincere gratitude to the IMPRI team for their guidance and support along with the reviewers Ms. Deepankshi Agnihotry and Ms. Ambika Sharma for their valuable feedback and insights.
Disclaimer
All views expressed in the article belong solely to the author and not necessarily to the organization
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