- We forecast more INR weakness, and now expect USD/INR to rise modestly above the 90 levels in 2026, targeting 90.80 by the September 2026 quarter. We have already been expecting INR to weaken and underperform, although we note FX outflow pressures have been more acute than we have anticipated thus far (see IndiaPulse: At a Crossroad). Our forecasts also imply continued INR weakness against key FX crosses such as EUR, JPY and CNY.
- Higher import needs and soft net FDI to weigh on INR: Our FX forecasts reflect our expectation for a wider current account deficit of 1.5% of GDP and soft net FDI flows. These should offset some improvement in portfolio inflows with our expectation of an eventual trade deal between US and India, where we assume tariffs will be lowered to 25% from 50% by early 2026.
- We expect RBI to actively intervene to cap USD/INR, but we think the fundamentals ultimately imply some pressure for INR to weaken, and as such for RBI to eventually allow USD/INR to break above 90 over time.
- RBI is close to the end of the rate cut cycle – We forecast one more repo rate cut, from our previous expectation of two cuts, bringing the repo rate to 5.25%. We think RBI could delay its rate cut to the February 2026 meeting from December, given the recent strong GDP print. Even then, our conviction for further rate cuts from here is much lower now, given continued pressure for FX outflows, strong reported GDP, coupled with a potential slowing in fiscal consolidation and concomitantly some fiscal support for growth.
- Risks tilt towards more INR weakness and RBI rate cuts if a trade deal is not reached: Our forecasts are certainly sensitive to tariff assumptions. If a trade deal between the US and India to lower tariffs is not reached, the bias would tilt towards further INR weakness and more RBI rate cuts, even as India’s domestic economy should continue to cushion India’s overall GDP.
- It’s important to emphasise we are not overly bearish on INR at current levels given cheaper FX valuations, coupled with stronger momentum for structural reforms which could over time unlock the binding constraints to growth. We have already seen India’s government accelerate reforms such as simplification of the GST and consolidation of labour codes, policy moves which probably would not have been possible without the external shock from the 50% tariffs. With the momentum on reforms picking up, coupled with recent wins on state elections by the incumbent government, we think FX vol can remain reasonably contained unlike in past cycles.
Details
- We raise our GDP forecasts to 7.6% for FY2025/26 and 7.1% for FY2026/27, on the back of stronger domestic demand from GST tax cuts, better rural activity, and assumption of a trade deal by early 2026. From a growth perspective, the direct impact of tariffs on India’s exports has been small so far, with some redirection of exports to markets such as the EU, China and the UAE. This is not to say that tariffs will not bite, and we think the longer tariffs stay at elevated levels the more prominent the negative impact will be. As a working assumption we see tariffs lowered to 25% in early 2026, down from the current 50%, but higher than India’s key export competitors. As such, while goods and services exports could soften, we think the downside should be capped by an expected trade deal. The indirect impact of tariffs through India’s move to cut and simplify GST taxes has nonetheless been meaningful for India’s growth, with a strong front-loaded bounce in consumption demand in October and November. The Rabi crop is likely to be decent given good reservoir levels, and this should support rural and agriculture activity into 1H2026. Meanwhile, the lagged impact of easier monetary policy should also provide some support to domestic demand in 2026.
- India’s balance of payments should see modest outflow pressure from a wider current account deficit and still elevated FDI Repatriation. The flipside of stronger domestic demand is that imports have picked up quite meaningfully, and we as such forecast the current account deficit to widen to US$64bn in FY2026/27 (1.5% of GDP). The run-rate of the trade deficit should average slightly under US$30bn through 2026, down from current levels of US$30-40bn but higher than what we saw in 2025.
- INR’s trajectory will also depend on whether the current account deficit can be financed through capital inflows. On that we forecast some improvement in portfolio inflows as the Fed cuts and a trade deal is agreed, coupled with some chunky FDI inflows from announced M&A in financial services. A meaningful decline in direct investment inflows continues to weigh on India’s balance of payments, and in particular elevated FDI repatriation as foreigners continue to take profit on existing investments given the valuation gap between India and other markets. For now, we do not expect a sustained increase in net FDI in 2026 but structural reform will be key to watch here. Indian government bonds could also be included in an upcoming review of the Bloomberg Barclays Global Aggregate Index, which could bring an incremental US$10-15bn of inflows, but for now we do not assume those flows officially in our INR FX forecasts.
- We now see RBI keeping rates at 5.25% through 2026 (from our previous forecast of 5%). We expect RBI to actively intervene to cap the pace of USD/INR upside: While inflation is low and manageable, some of this is due to GST rate cuts and also lower food prices, while the external position and FX outflow pressure implies that RBI will likely exercise more caution in further rate cuts in 2026. We have as such removed one RBI rate cut from our forecast profile. The fiscal position will also be key in 2026, with lower revenues from GST cuts making the path forward for fiscal consolidation more difficult, coupled with pressure from state governments to increase subsidies. We think RBI will continue to intervene in the FX market to cap USD/INR upside, but the fundamentals suggest an eventual acceptance by RBI to allow USD/INR to break modestly above the 90 level.
- Never let a good crisis go to waste – structural reforms could be key for INR’s longer-term trajectory: The good news is that India’s government has accelerated some long-standing structural reforms, and this is one reason why we are reluctant to be too bearish on INR, on top of cheaper FX valuations. These reforms include the consolidation of labour codes, simplification of GST, some removals of Quality Control Orders, acceleration of bilateral Free Trade Agreement negotiations, coupled with reported plans to raise FDI caps in the financial sector, among others
