'We believe the truth is in the middle, and that India is at an important crossroads.'
The backdrop in which the Budget is presented tends to set the tone. But this year it all seems rather confusing.
There are enough indicators to suggest that growth is both weak and strong.
Confusing Growth Signals
Some argue that growth is on an upward path. Real gross domestic product (GDP) growth prints have been strong, and credit growth is rising across several sectors.
Others lament that the best is over.
2025 benefitted from a series of one-time boosts -- good rains, falling oil prices, moderating inflation -- which were particularly beneficial for the informal sector.
Significant policy easing -- tax rate cuts helping consumption, as well as interest rate and regulatory easing -- added to the mix.
All of these may be largely behind us.
This group points out that nominal GDP growth has been extremely weak, and foreign inflows have been insufficient to fund the trade deficit.
Recent Purchasing Managers' Index prints, too, have started to slow after a strong run.
GDP vs Nominal Growth
We believe the truth is in the middle, and that India is at an important crossroads.
2025 was largely about the informal sector rising back up.
The opportunity now is for the formal sector to recover in 2026, on the back of the tailwinds from all the policy easing of 2025.
We are seeing some green shoots in the form of credit growth and a capital expenditure (capex) revival.
Credit growth is picking up, but the challenge is to keep it going for a sustained period.
Capex is rising in a few sectors, such as defence, electronics, power, and metals. But it is not broad-based.
In the past, strong investment that lifted domestic growth only happened in years when exports were strong.
A potential lowering of tariffs imposed by the United States on India's exports would play an important role here.
One-Time Growth Boosts Fade
What role can policymakers play to ensure a successful pivot from the informal to the formal sector, and from consumption to investment?
Two things can help -- a good balance between fiscal and monetary policy in the short run, and important reforms that raise returns and reduce risks in the medium term.
Informal Sector Recovery
Let's start with the first. Can fiscal and monetary policy move to a stable equilibrium that provides stability and predictability?
Can policy strike a good balance between the interests of the public and the private sector, as well as investors and savers?
A better balance is often related to the concept of neutral policy. But what does it mean in practice?
Capex Revival, Not Broad-Based
On the fiscal front, deficit and debt ratios remain elevated.
The central government aims to lower public debt ratios to pre-pandemic levels by FY31, which will require continued fiscal consolidation over the next five years.
In the forthcoming Budget, we expect the government to show continued restraint, lowering the fiscal deficit target for FY27 (to 4.2 per cent of GDP from 4.4 per cent in FY26).
To achieve this, we expect a consolidation in the number of schemes while holding on to infrastructure spend.
Neutral Policy Debate
The problem instead is with state government finances, where public debt ratios will continue to rise for the next few years, due to a lack of fiscal consolidation.
The silver lining is that the 3 per cent fiscal ceiling may begin to restrict the space for higher state deficits.
All said, fiscal policy will likely remain tight through 2026.
We track neutral monetary policy in a Taylor rule framework, which has worked well for India over the last decade.
Given our expectation that inflation will be just under the 4 per cent target next year (led partly by imported disinflation from China), our model suggests no pressure to raise rates. In fact, there is space for further easing if growth dips.
Bonds, Equities, Rupee Outlook
A combination of tight fiscal and easy monetary policy that creates a better economic balance should be positive for all asset classes as the year progresses, especially after a year of underperformance compared to other emerging markets.
On bonds, higher state borrowing for 1Q26 is already in the price, India's central bank is buying bonds, and we expect fiscal prudence in the Budget.
On equities, recent reform announcements, a gradual rise in nominal GDP growth, and more reasonable valuations should help.
On the currency, a lot of the rupee depreciation has already happened, while the improved bonds and equities outlook could raise portfolio inflows.
Policy Stability and Predictability
All of this can get you a one-time fillip.
For a sustained rise in the economy and markets, reforms are key.
Some important reforms have started over the last year, and we hope to see them being pursued more aggressively over 2026.
On the domestic front, these include the deregulation drive at the central and state government levels, respectively.
On the external front, these include the lowering of Custom duties and non-tariff barriers like quality control orders (QCO), and signing trade deals with not just the West (US and European Union), but also the East (in order to better integrate with regional supply chains).
But this is not where it ends. The reforms discussed above, if implemented well, can raise returns. But we equally need to lower risks.
And here, a focus on policy transparency, stability, and predictability is crucial.
The rules of the game, or their interpretation, should not be suddenly changed.
All of this can add to a more welcoming investment environment in this important policy season.
Key Points
- Growth signals are mixed, with strong real GDP prints but weak nominal growth and slowing PMIs.
- One-time boosts of 2025 are fading, raising concerns about growth sustainability.
- 2026 hinges on a formal-sector recovery, supported by credit growth and selective capex revival.
- Policy mix is key, with tight fiscal stance and scope for easier monetary policy.
- Reforms and policy predictability are crucial for sustained economic and market momentum.
Pranjul Bhandari is chief India economist and macro strategist, Asean economist, HSBC.
Feature Presentation: Ashish Narsale/Rediff
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