India’s Growth Gamble: Between Tariffs and Tax Cuts

Economic forecasting in India has been a volatile exercise this year. At the start of FY26, growth was projected at 6.5%. By spring, tariff uncertainty with America had dragged forecasts down to 6%. Then came a stronger-than-expected first quarter, supported by frontloaded government capital spending and a surge in exports to the United States before tariffs kicked in. The rebound pushed forecasts back to 6.5%

The seesaw reflects the cross-currents shaping the economy; domestic demand buoyed by tax cuts and GST reform, external demand constrained by protectionism abroad. The path ahead, most economists suggest, will be uneven, with a soft patch in the second quarter before stabilisation later in the year.

Rural Resilience, Urban Unease

The monsoon has been kind, reservoir levels are strong and sowing has crossed last year’s mark. That should provide insurance for future cropping cycles, shoring up rural consumption.

Urban households tell a different story. High-income groups are spending freely, treating luxury consumption as the new normal. Younger consumers are expected to splurge their GST savings on discretionary items and experiences. Middle-aged families, squeezed between the costs of children and ageing parents, remain cautious. The ₹2trn boost from GST rationalisation, though partly saved, is likely to translate into a burst of small-ticket spending across cities

Fiscal Manoeuvres

The government insists it will keep the fiscal deficit near 4.4% of GDP. A buffer of around ₹50,000 crore, aided by a windfall surplus from the Reserve Bank and healthier non-tax revenues, provides some cover. Yet competing demands are sharpening. Exporters facing tariff headwinds seek relief. Ambitions for capital expenditure could be curbed. And a looming pay commission may fuel consumption but crowd out infrastructure spending

Further clarity will come with the Finance Commission’s report, due before the next budget. The review will redraw centre-state fiscal relations for five years, with defence spending a likely priority after recent geopolitical strains. Fiscal consolidation, in short, will remain a contested goal.

Exports in the Crosshairs

India’s external accounts are steady for now. The current-account deficit is expected to hover around 1.2% of GDP

Services exports, particularly IT and global capability centres, continue to perform strongly. But merchandise exports face stormier weather.

America has slapped 50% tariffs on a wide range of Indian goods. Labour-intensive industries such as gems and jewellery, textiles and leather are among the most exposed. Auto components, pharmaceuticals and petroleum products are better insulated. Without progress in trade talks, India’s export base looks vulnerable. Economists warn that over the medium term, the larger question is not just where India will sell, but what it will sell to an ageing world economy.

Growth’s Natural Limits

Despite its demographic advantage, India’s long-term growth ceiling remains stubbornly fixed at 6.5–7%. To climb higher would require either an export boom or a private investment surge. Neither is in sight.

Capacity utilisation has risen above 75%, a level that usually prompts firms to invest. Yet surveys show little appetite for large capital spending in the next two to three years

Tariff uncertainty, global weakness and corporate caution conspire to keep investment subdued. Fiscal consolidation limits the government’s ability to step in. Breaking free from the growth corridor, economists argue, will be difficult without bolder reforms and a clearer export strategy.

Currency and Markets

The rupee, once the steadiest currency in Asia, has grown twitchy. Intraday volatility has returned as the Reserve Bank becomes less willing to intervene constantly. Policymakers seem prepared to tolerate a weaker currency, offering exporters some compensation for tariff pain

Bond markets, however, are uneasy. Repo cuts of 100 basis points earlier this year have not prevented yields from rising. The benchmark ten-year hovers around 6.5%, reflecting concern over fiscal discipline and mixed signals on borrowing.

Sectoral Divides

Sectoral prospects are diverging. Ratings agency ICRA sees capital goods and defence as bright spots, underpinned by government demand. Most sectors remain stable. But power distribution, chemicals, petrochemicals, cotton, polished diamonds and microfinance lenders are under pressure

Domestic-facing industries will benefit most from the GST boost; export-oriented firms remain at the mercy of global demand and tariffs.

A Precarious Balance

India enters the middle of the decade with respectable but limited growth. Inflation, unusually subdued at an average of 2.6% for the year, offers relief but not much policy room. Fiscal consolidation is a mantra in Delhi, though pressures for higher spending persist. Exports are constrained by global politics. Private investment is hesitant.

The economy is strong enough to maintain momentum, yet fragile enough to demand vigilance. Absent bold reforms or a shift in global demand, India’s growth gamble will remain what it has long been, a balancing act on a narrow tightrope.

These insights are drawn from Aditi Nayar’s session on ‘Sailing Through Global Headwinds: What Lies Ahead for India?’ at the recent CFONEXT100 conference. Aditi is the Chief Economist, Head – Research and Outreach, ICRA.