FORESIGHTS
Higher for longer, but how much longer?
In an article I wrote in November 2023, I argued that US interest rates will remain high for longer. This was against the general expectation of lower interest rates as the Federal Reserve was expected to reduce its policy rates. Now, 1.5 years later, and after a 100 bps reduction undertaken by the Federal Reserve, the interest rates continue to remain high.
The US 10-year treasury at 4.5% is almost at the same level as in November 2023. More importantly, there seems to be more consensus now that the interest rates will remain elevated. I will highlight the top 3 reasons why the US interest rates will likely remain high in the near future, and also dwell on what it means for us in India.
Firstly, the continued high fiscal deficit leads to higher borrowings and, hence, higher interest rates. The US fiscal deficit at 6.9% of GDP is amongst the highest across the developed world and resembles an emerging economy. The high debt-to-GDP ratio of over 120% also confirms this problem. In contrast, India’s debt-to-GDP is significantly lower, at around 81%. The forecast for the US fiscal deficit is also not so sanguine, based on low economic growth (tariffs and all) and upcoming tax concessions. All of it indicates a worsening fiscal situation.
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India’s growth momentum improves in the midst of global challenges
Concerns around India’s growth have been tempered down by the recent GDP data. The GDP growth of 7.4% for Q4 FY25 is much higher than market expectations. While the GDP growth at 6.5% for full FY25 is lower than the 9.2% growth recorded in FY24, it is still commendable amid global turbulence.
The GDP growth in Q4 has been led by a strong jump in investment growth (gross fixed capital formation) to 9.4%, from an average growth of 6.2% in the previous three quarters. The investment growth was mainly because of a sharp increase in the government’s capex in H2 FY25, after a dull H1 FY25. With concerns around weak urban demand, there has been a moderation in private consumption growth to 6% in Q4 from an average of 7.6% recorded in the previous three quarters.
In terms of sectors, agriculture grew by a healthy 4.6% in FY25, given the good monsoon last year. Manufacturing growth has been feeble at 4.5% in FY25, though there has been an improvement in growth momentum in the fourth quarter. Construction has been a very strong pillar for the economy, growing by 9.4% in FY25. The service sector has also maintained healthy momentum, growing by 7.2% in FY25. The critical question now is what to expect for FY26? Global trade policy uncertainty is likely to continue, and that would cast a shadow on global growth and capital flows. India would be relatively less impacted, given that it has lower trade exposure compared to many of its Asian peers. Nevertheless, India will also feel the pinch of this heightened global trade protectionism.
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The US dollar index (DXY) has declined 8.6% CYTD, falling below 100 for the first time since 2023. This would mark its steepest annual decline since 2017 if current levels hold. The weakness is largely driven by concerns about slower US growth and rising fiscal risks and is expected to persist. Meanwhile, many Asian currencies have strengthened. Even the Chinese yuan has gained against the dollar, though its appreciation has been modest as authorities are focused on maintaining currency stability.
For India, this external backdrop and strong domestic fundamentals have eased the weakening pressure on the rupee. After weakening through much of H2 FY25, the rupee has strengthened in recent months, appreciating around 2.8% from its February lows. In light of this, we have revised our USD/INR forecast to 85-87 by end-FY26 (from our previous forecast of 88-89). That said, FPI flows into India are likely to remain volatile. US trade policy and fiscal developments will have a strong bearing on dollar dynamics and will be important to watch in the coming months.
Rupee Outlook: Supported by Strong Fundamentals, though FPI Uncertainties Persist
The rupee has strengthened by around 2.8% against the dollar from its February lows. External factors, such as a weaker dollar and a stronger yuan, have eased the pressure on the rupee. The currency also remains supported by India’s manageable current account deficit (CAD).
We expect the CAD to stay comfortable at around 0.9% of GDP in FY26, supported by resilient services exports and lower crude oil prices. On the capital account side, global trade uncertainty may weigh on investor sentiment and keep FDI inflows muted in FY26. Net FDI inflows fell to just USD 0.4 billion in FY25, down 97% YoY, marking the fourth consecutive year of contraction. While gross inflows rose 13.7% YoY to USD 81 billion, this was offset by USD 51.5 billion in repatriation/disinvestment and USD 29.2 billion of FDI outflows from India.
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Import–Export Dynamics at a Glance
India-UK trade accounts for approximately 2% of India’s total trade, underscoring an underutilised partnership given the size and potential of both economies. To understand the macro dynamics, a few important data points are enumerated below:
Driven by a 10-12% CAGR, India-UK trade has shown consistent upward momentum. The decline in 2020 and 2021 was primarily attributed to factors such as the global recession and supply chain disruptions, largely arising from the COVID-19 pandemic and Brexit, among others. With the implementation of the FTA, considering a growth rate of about 15%, India’s exports and imports to and from the UK are expected to reach approximately GBP 45 billion and GBP 30 billion, respectively, by 2030, factoring in the aspect that the FTA will come into effect in a year.
Empowering India’s Export Ecosystem
Some of the benefits of FTA for Indian exporters would include improved market access, stable supply chains, increased competitiveness, higher volumes and new avenues for growth. The FTA is expected to boost India’s exports by significantly reducing tariffs, easing trade barriers, improving market access and making Indian products more price competitive, thereby increasing their demand in the UK. Additionally, this has provided some relief to exporters facing sluggish sales and uncertainty about potential reciprocal tariffs from the USA. According to the agreement, 99% of Indian tariff lines—representing nearly the entire trade value—will enjoy duty-free access to the UK market. Currently, most products face import duties ranging from 4% to 18% in the UK.
RMG export opportunities for India due to the India-UK FTA
India holds a 6% market share in the UK's RMG imports, while Bangladesh, Turkey, Cambodia, Vietnam, and Italy enjoy duty-free access, giving them a 12% tariff advantage over India. The India-UK FTA is a game changer for India’s RMG sector, creating a level playing field vis-à-vis key competing nations for accessing the UK's nearly US$20 billion RMG market.
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Overall MSME Credit MSME lending has witnessed robust growth in recent years, with Non-Banking Financial Companies (NBFCs) emerging as the front-runners, outpacing the growth rates of both private and public sector banks. Between FY21 and FY24, NBFCs recorded a 32% compound annual growth rate (CAGR) in MSME lending, albeit on a smaller base, compared to 20.9% for private banks and 10.4% for public sector banks.
The share of MSME credit in NBFCs' overall loan portfolio rose from 5.9% in FY21 to 9.1% in H1 FY25, an increase of over 50%. The banks maintained relatively stable MSME exposure, ranging from 16.2% to 16.9% over the same period. The Private sector banks have been gradually gaining market share from public sector peers. In FY24 alone, private banks expanded their MSME loan book by Rs 3.1 lakh crore, representing a 29% year-on-year increase, primarily driven by a 35% growth in micro-enterprise lending.
This expansion has been underpinned by a supportive ecosystem, including initiatives such as Udyam registration, GST Sahay, TREDS, and the development of digital public infrastructure, alongside enabling policy measures and credit guarantee schemes. Looking ahead, this growth trajectory is expected to persist, with NBFCs projected to grow at 20%, private banks at 15%, and public sector banks at 10% during FY25 and FY26
Care Rated MSME Micro LAP-focused NBFCs NBFCs, specialising in MSME Micro LAP lending, have experienced a 38.6% compound annual growth rate (CAGR) since FY20 till FY24, driven by their focus on underserved segments, government support, regulatory reforms, and technological advancements, such as Udyam registration. Their adoption of tech-based underwriting and data collection has enhanced outreach, while partnerships with traditional banks have further fuelled growth. By serving MSMEs that do not qualify for credit, these NBFCs address a crucial market gap.
CareEdge projects that their AUM will grow by 25% in FY25 and FY26, highlighting their increasing role in MSME financing and financial inclusion. Care-rated Micro LAP-focused NBFCs have doubled their branches from approximately 1,000 in FY21 to over 2,000 in FY24, supported by improved productivity, with the average disbursement per branch increasing from Rs 5.2 crore to Rs 10.3 crore. This expansion has resulted in higher initial operating expenses, with stabilisation expected to occur from FY24 onward.
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The Reserve Bank of India (RBI) has issued draft guidelines for public comments on “Securitisation of Stressed Assets Framework (SSAF), 2025” to regulated entities (REs) to securitise non-performing assets (NPAs). Currently, the resolution of NPAs is largely through asset reconstruction companies (ARCs) or bilateral loan transfers / IBC. The proposed SSAF seeks to provide a market-driven alternative to ARC-led resolutions, enabling a new set of investor participation in stressed asset securitisation. The proposed framework also provides for specialised resolution managers (ReM) for recoveries and stipulates valuation and provisioning norms.
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India’s GDP growth for the fourth quarter of FY25 came in at 7.4%, significantly exceeding expectations and signalling strong economic momentum. This brings full year FY25 growth to 6.5%, which is in line with the second advance estimate of MOSPI. The Q4 GVA growth stood at 6.8%, driven by a significant uptick in sectors such as manufacturing, construction, and financial, real estate, and professional services. The positive gap between GDP and GVA was on the expected line as growth in indirect taxes outpaced the subsidy growth. Agricultural growth remained healthy despite moderation. Better reservoir levels and robust Rabi sowing have supported the agriculture sector.
The growth in manufacturing improved to 4.8% in Q4 from 3.6% in Q3, while growth in construction activity jumped sharply to 10.8% in Q4 from 7.9% in Q3. The recovery in manufacturing and construction was largely in line with expectations. It was likely supported by strategic inventory front-loading by firms in anticipation of reciprocal tariff measures and strong government capital expenditure allocations during Q3. Although central government capex contracted by 4% during January–February 2025, robust end-of-quarter capex spending in Q3 helped sustain construction activity in Q4, consistent with the typical lag between capex deployment and its economic impact.
Financial, real estate, and professional services have supported the services sector, where growth improved to 7.8% in Q4 from 7.1% in Q3. However, contrary to expectations, growth in the trade, hotels, transport, communication, and broadcasting services segment slowed to 6% in Q4 from 6.7% in Q3, despite large-scale festivities such as the Kumbh Mela.
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