Saturday 17 / January / 2026
The year 2025 marked an inflection point: Policy overhauls across Western economies—particularly in trade, investment, and industrial policy—triggered spillover effects across all major global markets. India was not immune to these shifts. Intricately connected to global value chains, India, the world’s fourth-largest economy and a major global trading partner, faced external shocks and acute effects from these global policy changes, including tariff escalations and volatile capital flows.
Yet, despite headwinds, demand resilience, a reset in trade and investment outlook, and policy reforms stood out. India focused squarely on its biggest strength, domestic demand, to keep growth buoyant as inflation levels stayed low at 1.8% on average through the fiscal year.1 With slowing global demand, rising trade frictions, and a delicate domestic consumption environment, India deployed a carefully sequenced set of fiscal, monetary, and trade reforms that not only cushioned the economy but also laid the foundation for future growth.
Much of 2025 efforts comprised managing external shocks and strengthening domestic fundamentals. Consequently, a major milestone came in August 2025, when S&P upgraded India’s sovereign rating from BBB– to BBB—its first such upgrade in 18 years.2
As India enters 2026, several themes will shape the next phase of growth and demand the same level of pragmatism. We expect full fiscal year growth to be revised substantially upward, as third-quarter numbers are likely to remain strong due to festive spending. Growth is expected to stand between 7.5% and 7.8% in fiscal 2025 to 2026, and then between 6.6% and 6.9% in fiscal 2026 to 2027, buoyed by the rollout of new goods and services tax (GST) rules and slowing inflation.3
India’s domestic demand resilience
India’s economic value expanded by 8.2% year over year in the second quarter of fiscal 2025 to 2026,4 reinforcing expectations of an upward revision in full-year growth. Despite global headwinds such as higher US tariffs and volatile capital outflows, India posted an impressive 8% growth in the first half of the fiscal, powered by robust private consumption and investment, aided by easing inflation and favorable rural conditions.
Key drivers
Consumption: Private final consumption expenditure grew by 7.9% in the second quarter, supported by the lowest inflation level of 1.7% seen in a decade, rising disposable incomes from tax and GST relief, and better rainfall. Consumption grew by 7.5% in the first half of the fiscal.5
Investment: Government capital expenditure utilization rose to 51.8% in the first half of the fiscal year (versus 37.3% last year), boosting gross fixed capital formation growth to 7.6% (versus 6.7% last year).6
Sectoral strength: Gross value added (GVA) grew by 8.1% in the second quarter of the fiscal year, with manufacturing up 9.1% and services surging 9.2%, led by financial and professional services.7 GVA growth for the first half of the year came in at around 7.8%.8 Services now contribute 60% of GVA and 48% of exports, underscoring their strategic role.
Exports: After a strong first quarter, exports moderated in the second due to higher US tariffs on Indian exports (including a 50% tariff on select goods). But a trade rebound is expected, supported by upcoming trade agreements with the United States and the European Union, as well as diversification into services, electronics, and pharmaceuticals.
Growth momentum in Q3 is expected to continue to be strong, supported by resilient domestic demand. High-frequency indicators, including strong consumer confidence, vehicle registrations and sales, and easing inflationary pressures, point to continued support for economic activity. However, some external indicators such as currency depreciation and FPI outflows show emerging signs of stress, posing downside risks to the outlook.
Policy reforms
At the start of 2025, there were indications of macroeconomic stability: Inflation was tapering, the fiscal deficit was on a consolidation path, and growth levels were stable. However, there were early signs of economic strain as global policy and political relationships were changing fast, with clear effects on export prospects and real incomes. Policymakers recognized early in the year that if external demand were to weaken further, domestic demand stimulation would be imperative.
Fiscal
The year opened with optimism as the Union budget 2025–202610 signaled bold intent rather than scale. The government announced long-awaited direct tax exemptions for the middle-income class, which was under stress from persistent inflation, a modest post–COVID-19 labor market recovery, and elevated borrowing costs. By reducing personal tax burdens, policymakers aimed to lift disposable incomes, revive discretionary spending, and support small businesses reliant on domestic demand.
As global headwinds intensified through April 2025, the US decision to raise tariffs on select Indian goods added pressure on micro, small, and medium enterprises (MSMEs) and labor-intensive sectors such as seafood, textiles, apparel, and auto components.
In response, the government accelerated a key reform—the rationalization of GST slabs—ahead of the festive season to boost domestic demand (offsetting low export demand), aid informal sector recovery, strengthen tax compliance, and increase consumer spending.
With these measures, the government maintained high public capital expenditure (3.4% of gross domestic product in the first half of fiscal 2025 to 2026),11 particularly in infrastructure and green-transition projects like investments in renewables, ensuring domestic demand was the central growth pillar.
India has consolidated expenses, and the fiscal deficit is targeted at 4.4% of GDP this fiscal year,12 down from pandemic highs of 9.2% in fiscal 2020 to 2021. Disciplined expenditure management and buoyant revenue streams have, so far, helped government pursue growth-supporting measures.
Going forward, reforms—including the rollout of GST 2.0 and tax-relief measures—are unlikely to derail this trajectory. Higher nontax revenues, driven by an accelerated disinvestment pipeline and strategic asset monetization, are expected to offset potential shortfalls, ensuring fiscal prudence alongside growth.
Monetary policy
The government and the Reserve Bank of India (RBI) remained aligned in their resolve to strengthen domestic demand. While fiscal policy focused on boosting consumer spending through tax relief and public investment, monetary policy provided liquidity and cost-of-capital support needed to sustain the recovery.
Through 2024 and early 2025, India experienced an unexpected slowdown in credit growth, particularly in personal loans and small-business lending. The RBI recognized that, without stronger credit transmission, consumer spending recovery would lose momentum.
In response, the RBI delivered one of the sharpest easing cycles in recent history, cutting policy rates by a full percentage point within four months starting in February. With food inflation cooling sharply and global energy prices stable, the central bank used this window to shift decisively from prolonged tightening to an accommodative stance.
Still, credit expansion remained subdued, with bank credit growth stuck near 10%.13 This incomplete transmission likely contributed to the RBI’s additional 25-basis-point rate cut in the final policy review of 2025, even as macroeconomic fundamentals strengthened. The final cut signaled a commitment to sustaining domestic demand through 2026 amid global uncertainty.
The RBI’s policy easing is, however, not without concern. The India-US policy rate differential has narrowed to about 1.625 percentage points after the two countries decided on policy rate cuts in December. The 10-year bond yield differential remains within a 2.5% range. The differentials are close to their narrowest levels in a decade, raising the potential for capital outflows from India as investors seek higher yields when investing out of the United States (figure 1). Reinvestment of earnings has declined, while repatriations have increased in the past year.14 In 2025, foreign portfolio selling aggravated, with markets seeing close to US$18.4 billion in net foreign portfolio investment outflows during 2025 (as of Dec. 12, 2025)—the highest seen in 15-years.15
Recently, such investment withdrawals contributed significantly to currency depreciation—with the 90 rupees per US dollar mark being crossed. While the Indian rupee is expected to stabilize as the RBI intervenes in the market to contain volatility, persistent outflows and rising outbound foreign investment could pressure foreign exchange reserves and keep the rupee weaker in the near term. The good news is that amid volatility in foreign capital flows, strong retail participation in the capital market has helped stabilize market valuations despite foreign investment outflows.
