The world economy, including India, is going through heightened uncertainties as the global trade war aggravates. In the midst of this turmoil, the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) has indicated the need to support growth. The MPC, on expected lines, has cut the policy rate by 25 basis points and changed its stance from neutral to accommodative, which implies that due to concerns surrounding growth, there are chances of further rate cuts in the coming months.
With the ongoing trade war, the RBI governor has aptly highlighted that there are several known unknowns that make any quantification of the adverse impact difficult. The central bank has lowered India’s GDP growth projection for FY26 to 6.5 per cent from its earlier assessment of 6.7 per cent. We feel, however, that the dent on India’s growth could be deeper. We make this assessment while acknowledging that India will be relatively less impacted by US tariffs compared to some other Asian economies, given that its economy is mainly domestic-driven. Goods and services exports contribute around 21 per cent to India’s GDP and the goods exports-to-GDP ratio is even lower, at 12 per cent of GDP. For Thailand and Vietnam, the ratio of goods and services exports to GDP is much higher at 65 per cent and 87 per cent respectively. Hence, the impact of the trade war would be more severe on these economies.
Nevertheless, India will also feel the pain of the tariffs. We estimate the direct impact to be at around 0.2-0.3 per cent of GDP. Moreover, there will be a severe indirect impact as global growth and capital flows to emerging economies both decline. India’s domestic investors will also grow wary due to the ongoing global disruptions. Hence, private sector investment, which had been slowly picking up after Covid, could remain tepid in the coming quarters. We expect India’s GDP growth to moderate to around 6.2 per cent in FY26.
The supporting factor for the economy would be the chances of a normal monsoon and healthy agricultural production. This would aid rural demand, which has seen signs of improvement. In fact, overall consumption demand would get a fillip from a lower income tax burden and a moderation in food inflation. However, global economic concerns and the ensuing volatility in financial markets will somewhat overshadow some of these domestic positives.
Another positive for the Indian economy is that the reciprocal tariff imposed by the US at 26 per cent is lower than that imposed on some of the other competing countries. For China, the tariff imposed by the US is at a high of 104 per cent (considering the additional tariff imposed with China’s retaliation), for Vietnam it is 46 per cent and for Thailand 36 per cent. This opens a window of opportunity for India to increase its market share in exports to the US. The critical aspect will be India’s ability to tap into this opportunity.
While growth concerns have escalated, inflationary concerns have abated for the Indian economy. Consumer Price Index (CPI) inflation moderated to 3.6 per cent in February 2025 and is likely to remain below 4 per cent in the next few months. The comforting factor has been the sharp fall in food inflation to 3.8 per cent in February 2025 from an average of 8.5 per cent in October to December 2024. Moreover, core inflation has remained subdued at an average of 3.5 per cent in the past year. The RBI has trimmed the CPI inflation projection for FY26 to 4 per cent from their previous estimate of 4.2 per cent. Expectations of a normal monsoon and a softening of global commodity prices will be supportive of muted inflation. However, we need to remain watchful of the impact of weather-related disturbances on food inflation.
While the RBI has clearly indicated that going forward, the focus will be on supporting growth, the interesting aspect will be the action taken by some of the other central banks around the world. The trade war is likely to dent the growth of the US economy, while also exerting inflationary pressure. This will make the task of the US Federal Reserve more difficult. If the Fed gives precedence to growth concerns and initiates further rate cuts in 2025, it will make it easier for India’s central bank to continue its rate-cutting cycle. The European Central Bank and the Bank of England are also expected to cut rates further in 2025.
The other important aspect will be the interplay of currency dynamics. Historically, we have seen global currency wars playing out to gain export competitiveness. In the last few months, we have seen high volatility in the global forex markets. Between October 2024 and mid-January this year, the US dollar strengthened by 9 per cent, and thereafter, it has weakened by around 6 per cent. With fears of a trade war, the Chinese yuan weakened by 4.6 per cent in the last six months. The rupee saw a sharp weakening — 4.4 per cent — between October 2024 and February 2025. However, in the last month, we have again seen some strengthening of the rupee.
Capital inflows into the Indian market are likely to be muted in the midst of global uncertainty and that could put some pressure on the rupee in the medium term. Any weakness in the Chinese yuan, to offset the impact of higher tariffs, will also put pressure on the rupee. We expect the rupee to trade around the 88-89 level by the end of the fiscal year. The RBI will continue intervening to avoid sharp volatility. With forex reserves at around $676 billion (11 months of import cover), the RBI has the ammunition to intervene as and when required.
The RBI is likely to cut rates by a further 50 basis points in FY26. In fact, there is a possibility of the rate cut cycle being even deeper if the global trade war severely hampers growth prospects. Aided by the RBI’s intervention, the liquidity condition in the money market has improved, with banking system liquidity moving to surplus from the deficit seen in March. It will, therefore, be critical for the central bank to ensure smooth policy rate cut transmission by the banks.
The writer is chief economist, CareEdge Ratings
