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With fiscal and monetary headwinds receding, GDP growth has picked up in FY26. In FY27, the pace of fiscal consolidation should slow further (20bps), and lagged effects of monetary easing should become visible, pushing growth to 7.5% (above trend). Regulatory reforms are likely to continue, supporting upgrades to trend-growth assumptions. Given the economic slack, the economy can sustain above-trend growth for a few years before inflationary pressures build up. Together with better management of the duration of bonds issued, and growing demand, 10-year yields can drift down to 6.1%, in our view. With the REER falling sharply, and BoP trends supportive, we expect INR depreciation pressures to abate.
India to remain the fastest growing large economy
Headwinds to growth from mostly intended fiscal and largely unintended monetary tightening that slowed the economy in FY25 have abated, resulting in the growth revival in FY26. In FY27 we expect monetary easing to drive above-trend growth of 7.5%; while regulatory easing (e.g., EoDB, revoked QCOs, new labour codes) boosts growth over the medium-term, their announcement boosts sentiment. Given significant economic slack, growth can stay above-trend for a while before inflationary pressures warrant policy tightening. While labour growth and global demand remain modest, sustained TFP gains (1.5–2%) and a rebound in capital formation, led by manufacturing, utilities, and real estate, support a 7% trend growth outlook. FY27 consensus appears conservative.
Weak inflation to persist, G-Sec yields to inch lower
That core inflation ex-precious metals is below 3% is well understood, but academic research, backed by Indian data, suggests median inflation is a better gauge of underlying price pressures. This has been stable near 3% for 18 months and signals persistent slack in the economy. This is why, despite the above-trend growth and a rebound in food prices, we expect FY27 headline inflation to average 4%. While policy rates have likely bottomed, to aid monetary transmission and boost credit growth, money supply can rise further, and supply-side measures (like issuing more T-bills and shorter-duration bonds) can reduce steepness of the yield curve. We expect 10Y yields to drift towards 6% in FY27.
India’s external balance stable, USDINR weakness helps
The INR’s recent weakness despite low inflation has brought the REER to competitive levels. We do not see an unduly stressed Balance-of-Payments. The impact of the surge in investor demand for gold, which is keeping import volumes high despite 50% higher prices is offset by weak oil prices. A higher non-oil/gold deficit due to a recovering economy and Chinese competition in export markets can be paid for by the continuing double-digit growth in net services exports. We expect the current account deficit to widen marginally to 1.2/1.3% of GDP in FY26/27 respectively. FDI repatriation and nearly worst-ever FPI outflows have pressured capital inflows, but we expect these to be temporary
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