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It’s now official. The International Monetary Fund’s latest outlook confirms that global growth is likely to decline, with risks skewed to the downside. A tariff-driven stagflationary shock for the United States, and a demand shock for the rest of the world are likely ahead.
What does this mean for India, and how should we position ourselves? The answer lies in assessing the impact through both a cyclical and a strategic lens.
The cyclical lens
The immediate impact is negative for growth. India’s ultimate exposure to the US — its direct exports to the US, and its value added in other countries’ exports to the US — is around 2 per cent of gross domestic product (GDP). The direct growth impact from sectoral and reciprocal tariffs is likely to be around 0.2 to 0.3 percentage points.
The impact varies across export products, depending on the price elasticity of demand and the ability to substitute. For example, gems and jewellery exports are vulnerable, as they are driven by discretionary demand, while the burden of auto tariffs could be shared between exporters, US-based firms, and consumers.
There are also indirect effects to consider. Uncertainty and weak global demand will further delay private investments. Information technology (IT) services exports will be hit due to slower discretionary spending. The deterioration in confidence, tighter financial conditions, and slower job and income growth will also weigh on overall demand.
There are some positive offsets. Near-term trade diversion is likely in sectors like electronics. Lower commodity prices will ease input cost pressures and improve the terms of trade. Above-normal monsoons and lower inflation are positives for rural consumption. All considered, though, the negatives will dominate. While consensus expects GDP growth in the 6.2–6.5 per cent range in FY26, this seems optimistic; we expect 5.8 per cent.
Inflation is not a concern. While vegetable prices remain vulnerable to weather fluctuations, the current fall in food inflation is broad-based, and higher crop output and prospects for above-normal rains are a positive. Lower oil prices also influence food prices, as they can ease freight and transport costs.
China’s overcapacity, a negative output gap, low input costs, and lower wage growth all suggest core inflation will remain contained. We expect headline inflation to remain sub-4 per cent over the next three quarters and to average about 4 per cent in FY26.
Countercyclical toolkit
The macro outlook calls for a countercyclical policy response. Monetary policy remains the first line of defence, given the negative output gap, low inflation, and high real rates.
The external sector should be monitored, but it is unlikely to be a constraint. Weak exports and lower remittances should be offset by lower imports due to falling oil prices. Foreign capital flows may remain volatile, but the US dollar itself is on a weak footing, given its overvaluation and fading US exceptionalism.
This clears the deck for monetary policy and should enable the Reserve Bank of India (RBI) to decouple from the Federal Reserve. We estimate India’s nominal neutral rate to be around 5.5 per cent. However, with a negative output gap and inflation at target, policy rates can afford to be accommodative. We see room for another 100 basis points of rate cuts, bringing the repo rate down to 5 per cent.
Other tools should be used in conjunction. A sustained durable liquidity surplus using all available tools — open market operations, foreign exchange (FX) swap and long-term variable rate repo — will enable faster transmission. Countercyclical macroprudential easing can encourage banks to lend to targeted sectors. If capital inflows are durable, they should be used to build FX reserves and reduce the net short dollar forward book.
In contrast to monetary policy, fiscal space is limited. Targeted support for exporters can be extended. Unlike FY25, when elections delayed capex, government spending should be prioritised right from the start in FY26. Some fiscal cushion is possible due to RBI dividends and the excise duty hike on fuels, but there are downside risks due to lower nominal GDP growth, slower direct tax collections, and on disinvestments. Fiscal stimulus as a countercyclical tool should be the last resort.
The strategic lens
Beyond the cyclical priorities, there are strategic issues to consider. The US goal of a strategic decoupling from China is evident from the higher tariffs imposed on China, and US Treasury Secretary Scott Bessent’s “grand encirclement” strategy, which aims to form a coalition of countries that isolate China. Regardless of whether this works, India needs its own plan.
The US is India’s strategic ally, and the immediate priority is the bilateral trade agreement. With an early start to negotiations, India has a head start over its peers. India can offer a zero-for-zero tariff deal for industrial goods, buy more US products, and reduce non-tariff barriers that also address domestic inefficiencies. However, only a selective opening may be feasible in agriculture.
An early trade deal with the US can help in two ways. It can lower India’s reciprocal tariff rate, giving it a relative tariff advantage over competitors. India can also benefit more from the next round of supply-chain shifts, which are likely to be based on geopolitical alignments.
In our view, there is space for India to make its mark in low- to mid-tech manufacturing. There is no reason to believe successes in the smartphone space cannot be replicated in other areas such as computers, toys, textiles and footwear. India can also leverage its domestic market as a carrot to attract multinational corporations. India also needs a China strategy. China is an important source of intermediate goods imports that are essential for both exports (electronics, pharma) and domestic markets (solar). More localisation and diversifying sources of critical imports can build resilience. Higher US tariffs on China also mean a greater risk of dumping and re-routing of these products via India. This will require close monitoring and stricter enforcement of rules of origin.
Conclusion
Overall, the tariff shock under Trump 2.0 has changed the macro landscape. In the near term, growth will likely take a larger-than-expected hit, requiring a ready countercyclical policy toolkit. Over the medium term, more trade fragmentation is probable, but India can still capture a bigger share of the global manufacturing pie.
The stakes are high, but if we play our cards well, this could still reshape India’s medium-term growth trajectory.
The writer is chief economist (India and Asia ex-Japan) at Nomura
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
