Moody’s Ratings on Wednesday projected that India’s economic growth will surpass 6.5% in the next fiscal year (FY26), up from 6.3% in FY25. The upbeat outlook is anchored in a combination of higher government capital expenditure, consumption support through tax cuts, and monetary easing by the Reserve Bank of India (RBI). This forecast comes on the back of a temporary slowdown observed in mid-2024, with expectations that India will soon record one of the fastest growth rates among large economies globally.

In this comprehensive analysis, we delve into the key drivers behind Moody’s projection, examine the supportive fiscal and monetary policy measures, assess the outlook for India’s banking sector, and consider the global context shaping India’s economic trajectory. With the Finance Ministry’s Economic Survey projecting GDP growth between 6.3% and 6.8% for FY26, the stage is set for an exciting phase of economic reacceleration and transformation.

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A New Phase of Economic Resurgence

India’s growth story has been characterized by resilience and dynamism, even in the face of global uncertainties and domestic challenges. The current projection—rising from an estimated 6.3% growth in FY25 to over 6.5% in FY26—reflects a rebound from the temporary slowdown seen in mid-2024, when real GDP growth dipped to 5.6% in the July–September quarter before recovering to 6.2% in the subsequent quarter.

This robust recovery is driven by several factors. Chief among these is the government’s strategic emphasis on boosting capital expenditure. Enhanced spending on infrastructure projects is expected to not only create jobs but also to improve overall productivity, thereby fueling further growth. Additionally, targeted tax cuts aimed at middle-income groups are anticipated to stimulate consumption, while monetary easing measures—including recent rate cuts—are poised to lower borrowing costs and support investment.

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Key Growth Drivers: Fiscal and Monetary Policy

Government Capital Expenditure and Infrastructure Investment

One of the most significant components of India’s growth forecast is the government’s commitment to ramp up capital expenditure. In recent years, the government has prioritized infrastructure projects ranging from road and rail networks to digital infrastructure and urban development. These investments are not only expected to create immediate economic activity but also to lay the foundation for long-term growth by improving connectivity and efficiency across various sectors.

Recent announcements by the Ministry of Finance suggest that upcoming fiscal budgets will see a substantial increase in capital spending. This aligns with Moody’s view that higher government capex will drive the economy forward in FY26, catalyzing improvements in sectors as diverse as construction, manufacturing, and services.

Consumption Boost Through Tax Cuts

Tax cuts for the middle class form another pillar of the growth strategy. By increasing disposable incomes, these measures are expected to stimulate domestic consumption—a critical driver of economic expansion in a country where consumer spending accounts for a large share of GDP. With a significant portion of the population moving into higher income brackets, the resultant boost in purchasing power could transform the domestic market, further reinforcing growth momentum.

Monetary Easing and RBI Policy Adjustments

On the monetary policy front, the RBI has played a pivotal role in creating a conducive environment for economic activity. In an effort to tame inflationary pressures, the central bank had raised its policy rate by 250 basis points between May 2022 and February 2023. However, with inflation gradually easing, the RBI has since reversed course. A notable policy rate cut of 25 basis points in February 2025 brought the benchmark rate down to 6.25%, providing relief to borrowers and encouraging investment.

Moody’s expects that further rate cuts will be modest as the RBI maintains a cautious stance amid global uncertainties—particularly those related to US trade policies and exchange rate volatility driven by a strengthening US dollar against emerging market currencies. The gradual easing of policy rates is expected to help lower financing costs across the board, thus supporting both consumption and investment.

Impact on Inflation

In tandem with growth-enhancing measures, Moody’s anticipates a decline in India’s average inflation rate—from 4.8% in FY25 to around 4.5% in FY26. This projected moderation in inflation is critical for maintaining real purchasing power and ensuring that growth is both sustainable and inclusive. With lower inflation, households can spend more on goods and services, and businesses can invest with greater confidence in a stable economic environment.

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Banking Sector Outlook: Resilience Amid Challenges

While the overall economic outlook is optimistic, Moody’s has highlighted some cautionary notes regarding the banking sector. The operating environment for Indian banks is expected to remain favorable, yet there is concern that asset quality could deteriorate moderately after substantial improvements seen in previous years. Specifically, stress is anticipated in unsecured retail loans, microfinance loans, and small business loans—a reflection of the evolving risk landscape in the credit market.

Profitability and Net Interest Margins

Despite the potential for some asset quality issues, banks are forecast to maintain adequate profitability. The impact on net interest margins (NIMs) is expected to be marginal, thanks largely to the modest nature of the recent and anticipated rate cuts. This balance between cautious lending and steady income from interest will be critical in ensuring that banks can continue to support the economic expansion without compromising financial stability.

System-Wide Loan Growth

Moody’s also projects a moderation in system-wide loan growth, with rates expected to slow to 11-13% in FY26 from an average of 17% observed between March 2022 and March 2024. This deceleration is partly a reflection of banks’ efforts to keep loan growth in line with deposit expansion—a prudent strategy aimed at preserving the overall health of the financial system in an environment of cautious monetary easing.

Balancing Risk and Growth

As the economy expands, banks will need to carefully balance the dual imperatives of growth and risk management. While increased lending can fuel economic activity, it also raises the potential for higher default rates, particularly in segments like unsecured retail lending. Policymakers and regulators will have to monitor these developments closely, ensuring that credit expansion does not lead to excessive risk-taking that could undermine financial stability.

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Global Economic Context and External Influences

India’s economic prospects are also being shaped by a broader global context. Amid persistent global uncertainties—including trade policy shifts and market volatility—India is emerging as a beacon of growth among large economies. As other major economies grapple with slower growth and structural challenges, India’s proactive policy measures and robust domestic fundamentals position it to capitalize on emerging opportunities.

US Dollar Strength and Trade Uncertainty

One of the key external factors influencing India’s economic outlook is the volatility of the US dollar. In recent months, the US dollar has strengthened against many emerging market currencies, a trend driven in part by uncertainties in US trade policies and broader geopolitical tensions. This currency strength can have a dual impact: while it may pose challenges for export competitiveness, it also underscores the relative resilience of the Indian economy amid global turbulence.

The RBI’s cautious approach to further rate cuts reflects these concerns. By carefully calibrating monetary policy in response to global developments, the central bank aims to shield the domestic economy from adverse external shocks while still promoting growth.

Comparative Growth Among Large Economies

Moody’s projection that India could record one of the fastest growth rates among large economies is significant in the context of global economic trends. Many advanced economies are experiencing sluggish growth or are caught in a cycle of restrictive fiscal and monetary policies. In contrast, India’s targeted fiscal stimulus and proactive monetary easing are providing a much-needed boost to domestic demand, positioning the country as a growth leader in the coming years.

Foreign Direct Investment and Global Trade

Another factor contributing to India’s positive outlook is the inflow of foreign direct investment (FDI). In recent years, India has implemented a range of structural reforms aimed at attracting FDI, particularly in high-growth sectors such as technology, manufacturing, and renewable energy. Enhanced investor confidence, bolstered by the country’s strong economic fundamentals and reform agenda, is likely to further support growth in FY26.

Additionally, global trade dynamics continue to evolve, with emerging markets increasingly playing a pivotal role in shaping the future of international commerce. India’s strategic geographic location, combined with its expanding industrial base, makes it an attractive destination for companies looking to diversify their supply chains and tap into new consumer markets.

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Challenges and Risks Ahead

Despite the optimistic growth outlook, several challenges remain that could temper India’s economic expansion. Chief among these are the potential risks associated with asset quality in the banking sector and the broader impact of global uncertainties on domestic policy.

Asset Quality Concerns

As previously mentioned, while banks are expected to remain profitable, there is a risk that asset quality may deteriorate—especially in the segments of unsecured retail loans, microfinance, and small business loans. A worsening in these areas could lead to higher non-performing asset (NPA) ratios, which in turn might necessitate stricter lending norms or increased provisions, thereby slowing down credit growth.

Global Economic Volatility

On the international front, persistent volatility in global markets—driven by trade disputes, geopolitical tensions, and fluctuations in commodity prices—poses a risk to India’s export sector and overall economic stability. A significant deterioration in global economic conditions could undermine investor confidence and lead to a tightening of global financial conditions, which may impact India’s growth trajectory.

Policy Implementation and Structural Reforms

The success of India’s growth strategy hinges on the effective implementation of key policy measures, including increased capital expenditure and targeted tax reforms. Any delays or shortcomings in these initiatives could dampen the expected boost to domestic demand. Moreover, while structural reforms have been a hallmark of India’s recent economic agenda, their long-term impact will depend on consistent and sustained policy efforts.

Balancing Growth and Inflation

Although Moody’s expects inflation to moderate, maintaining this balance will require vigilant monitoring. A surge in demand fueled by fiscal and monetary stimulus could, if not managed carefully, lead to overheating and a subsequent spike in inflationary pressures. The RBI’s cautious stance on further rate cuts reflects an awareness of this delicate balance, underscoring the importance of maintaining a stable macroeconomic environment.

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Outlook: A Path to Sustainable Growth

Looking ahead, India’s economic prospects for FY26 appear robust, driven by a combination of proactive fiscal measures, a supportive monetary environment, and resilient domestic fundamentals. The government’s emphasis on capital expenditure, coupled with targeted tax cuts and measured monetary easing, is poised to create a conducive environment for growth. Moreover, India’s position as one of the fastest-growing large economies is likely to attract further investment—both domestic and foreign—bolstering the country’s overall economic dynamism.

The banking sector, despite facing challenges related to asset quality, is expected to navigate this period of expansion with relative stability. By moderating loan growth and aligning credit expansion with deposit growth, banks can continue to support the broader economy without compromising financial stability.

In the global context, India’s emergence as a growth leader is particularly noteworthy. While many advanced economies grapple with stagnation or slow recovery, India’s focused policy interventions and strong consumer market provide a stark contrast. This divergence is likely to enhance India’s role in global trade and investment, further reinforcing its economic resilience.

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Concluding Reflections

Moody’s projection that India’s GDP growth will exceed 6.5% in FY26 is a testament to the country’s dynamic policy environment and robust economic fundamentals. The forecast reflects a synthesis of factors—from increased government spending and tax reforms to strategic monetary easing—all of which are converging to support a strong growth trajectory.

At the same time, it is important to recognize the challenges that lie ahead. The potential for deteriorating asset quality in the banking sector, global economic volatility, and the critical need for effective policy implementation all represent areas that will require careful management. Nevertheless, the overall outlook remains positive, with India well-positioned to not only sustain its growth momentum but also to emerge as a leading force among the world’s major economies.

As policymakers continue to navigate a complex global environment, the balancing act between stimulating growth and managing risk will be paramount. With a clear focus on infrastructure development, fiscal prudence, and monetary stability, India is charting a course toward a future of sustainable and inclusive economic expansion.

In summary, the convergence of higher government capital expenditure, targeted tax cuts, and a supportive monetary policy framework is set to drive India’s real GDP growth to exceed 6.5% in FY26. While challenges persist, the proactive steps taken by the government and the RBI, coupled with the resilience of India’s domestic market, offer a promising outlook for the country’s economic future. As India continues to implement structural reforms and attract global investment, it is poised to solidify its status as one of the fastest-growing large economies in the coming years—a development that will have far-reaching implications for both domestic prosperity and global economic dynamics.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

13th March, 2025