India amid global strain: Rate cut relief versus trade war challenges

The Indian economy, with its low external trade exposure, is better placed than many other countries amid the global trade war. However, in an increasingly interconnected world, it cannot remain entirely insulated from heightened global uncertainties. India’s gross domestic product (GDP) growth had already been moderating even before the trade war erupted. Broad-based consumption spending remains elusive, while private investment is still not roaring back. The global trade war is likely to further dent India’s economic growth outlook.

 

The silver lining amid these growth concerns is the moderation in domestic inflation. With comfort on the inflation front, the Reserve Bank of India (RBI) has shifted focus on supporting growth, cutting interest rates twice (a cumulative 50 basis points), and adopting an accommodative stance — signalling the possibility of further rate cuts.

 

India’s GDP growth is estimated to moderate to 6.5 per cent in FY25, down from an average of 8.4 per cent over the past two financial years. The slowdown can be attributed to a pause in government investment — largely due to the election cycle — even as private investment remained feeble. Moreover, there has been some dwindling in urban consumption spending, though rural consumption has continued to improve. GDP growth is expected to pick up sharply in Q4 FY25, led by a bounce-back in government investment and increased spending in this quarter due to the Maha Kumbh. However, this does not take away the deeper pain in the economy in the form of a weak job market, dampened consumer sentiment, and the uncertain private investment scenario.

 

As we enter FY26, the reduction in income tax burden and lower inflation are expected to provide some spur to consumer spending. With expectations of a normal monsoon, the pickup in rural demand should continue. Lower interest rates would be another supportive factor in driving growth. However, global uncertainties could overshadow some of these positives for the economy. With goods exports to the US accounting for only 2 per cent of India’s GDP and a relatively low reciprocal tariff of 26 per cent, we estimate the direct impact of the higher tariff to be limited to around 0.2–0.3 per cent of GDP.

 

However, the indirect impact of the trade war could be more severe. As global growth slows, there will be repercussions on India’s overall exports, including services exports. Over the last six years, India’s goods exports have grown at a compound annual growth rate (CAGR) of 6 per cent, while services exports (led by IT/ITES and global capability centres or GCCs) have grown by 12 per cent. India’s services exports could also feel the pinch if global growth falters severely. The IT and IT-enabled sectors are major employment generators; hence, any weakness in this segment could also dent the job market and consumer sentiment.

 

The global turmoil could also have adverse implications for capital flows into India. Net foreign direct investment (FDI) inflows into the country slowed to $1.4 billion during the first 10 months of FY25, down from $11.5 billion in the same period of FY24. Moreover, net foreign institutional investor (FII) inflows were muted at $2.7 billion in FY25, compared to $41 billion in FY24. Capital flows into the economy could remain weak in FY26. Private investment may also remain on a slow growth trajectory, given the uncertain economic environment. We expect GDP growth to moderate to 6.2 per cent in FY26. There are some opportunities for India arising from the trade war, as some of its Asian peers face higher reciprocal tariffs. However, it will be critical for the government to speed up the reform process in order to tap into this global opportunity.

 

While economic growth concerns have aggravated in the last few months, inflation concerns have abated. Consumer Price Index inflation fell to 3.3 per cent in March 2025 from a high of 6.2 per cent in October 2024. This was supported by a moderation in food inflation, while core inflation remains comfortably around 4 per cent. Expectations of a normal monsoon and the softening of global commodity prices are likely to keep inflation in check in FY26. Global crude oil prices have fallen by around 15 per cent compared to last year and are estimated to remain benign in FY26. However, we need to remain cautious of any supply bottlenecks amid ongoing geopolitical conflicts. Weather-related disruptions and their consequent impact on food inflation are the other major risks we need to be wary of.

 

There is also the risk of imported inflation in case of any sharp weakening of the rupee in the midst of the trade war. However, with food inflation moderating and core inflation under control, we need not worry too much about inflationary risk. Moreover, we do not expect a sharp and sustained weakening of the rupee in FY26, as the US growth outlook worsens, with repercussions for the US dollar.

 

The RBI is likely to cut rates by a further 50 bps in FY26. The rate-cutting cycle could be deeper if the global growth gets severely dented by the trade war. The task of the US Fed will be more difficult, given the growth concerns and inflationary risks in the US economy. If the Fed gives precedence to growth concerns and continues with rate cuts in 2025, that would make it easier for the RBI to continue its rate-cutting cycle. While lower interest rates would provide comfort to the Indian economy, the main concern would be the dented consumer and business sentiment amidst the global turmoil.

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The writer is chief economist at CareEdge Ratings