- The US and India announced a trade deal to lower tariffs to 18% from 50%, in a surprise move overnight by the leaders of both countries.
- The announcement is a positive surprise for both the markets and ourselves in two key ways. First, it came earlier than expected, and relative to our expectation for a deal to be concluded in 2H this year. Second, India's relative tariff differentials to its export competitors also came in better than we had assumed.
- Near-term, we lean towards seeing USD/INR trading lower given these dynamics, and would watch closely to see if key support levels around 89.50 to 90.00 hold. RBI's FX intervention actions could also be key here to gauge near-term price action, including whether RBI buys or sell Dollars.
- Medium-term, we hold onto our view for USD/INR to move higher, and as such think moves lower in USD/INR over time are good opportunities for corporates and our clients to rebuild long USD/INR positions for this year (see India - Flows before Growth: This time is different for INR).
- Overall, we tentatively adjust our forecasts and target USD/INR at 89.50 in 1Q2026 and 93.00 by 4Q2026 (from 91.50 and 94.00 previously), implying some frontloading of portfolio inflows from what we anticipated previously.
- From a rates perspective, we continue to see RBI keeping rates hold at 5.25% through our forecast horizon, and think the trade deal lowers the probability of rate cuts. We now see INR 10 year bond yields rising and grinding higher towards 7% by 4Q2026 (from our previous forecast of 6.80%), and continue to see FX forward premia remaining elevated (but less so than before).
Details
- The US and India announced a trade deal to lower tariffs to 18% from 50%, in a surprise move overnight by the leaders of both countries. This comprises the removal of the 25% tariffs for India's purchases of Russian oil, together with a reduction in reciprocal tariffs from 25% to 18%. After accounting for exemptions, we estimate that effective average tariffs for India has gone down to 15% from 35% previously. According to the social media post by Trump, India will purchase US$500bn in US energy, technology, agriculture, coal and other products, has agreed to stop buying Russian oil, while India will also eliminate tariffs and non-tariff barriers to zero. Details are still scarce at this point, and we take the claims around full elimination on tariffs and non-tariff barriers with a meaningful grain of salt, especially in areas such as agriculture and the automotive sector. There are also some important questions around possible conditionality of the deal, including whether the tariffs are tied to magnitude of Russian oil purchase by India.
- All things considered, the trade deal is a positive surprise for both the markets and ourselves in two key ways.
- First, it came earlier than expected, and relative to our expectation for a deal to be concluded in 2H this year. We had pushed out our assumption of the timing of a trade deal from 1Q2026 earlier given mixed public signals by US officials, and so today's announcement came as a positive surprise to us.
- Second, relative tariff differentials also came in better than we had anticipated. We were assuming that India's tariffs fall to 25% - lower than the exorbitant 50% tariffs but higher relative to India's key export competitors. With today's announcement of 18% tariffs, this implies a greater competitiveness for India's exporters in the US market, especially in labour intensive export sectors such as textiles, gems and jewellery, leather, furniture, carpets among others.
- Near-term, we lean towards seeing USD/INR trading lower from a markets perspective given these dynamics, and would watch closely to see if key support levels around 89.50 to 90.00 hold. We also see a chance that RBI could come in more forcefully to intervene to push USD/INR lower and as such are wary for now given how the market is positioned and exporters are likely under-hedged. In addition, India's trade deficit seasonality also gets better and more helpful for INR as we head towards Feb/March.
- Last but not least, we note that IPO deal announcements have slowed down in recent months, and this may start to reduce the extent of outflows near-term. This is a dynamic we saw back in Feb/March 2025, but of course it was somewhat different back then with a greater magnitude of US Dollar weakness, a better portfolio and FDI flow dynamic, coupled with some expectation that India will get a materially better trade deal than others.
- Medium-term, we hold onto our view for USD/INR to move higher, and as such think moves lower in USD/INR over time are good opportunities for corporates and our clients to rebuild long USD/INR positions for this year.
- First, the fundamentals of rising gross FDI repatriation for 2026 has not changed, and our analysis of the strong IPO market pipeline shows that foreigners will likely to continue to exit and take profits on their investments in India, and correspondingly put pressure on INR to weaken (see India – Flows before Growth: This time is different for INR).
- Second, India's current account deficit is still expected to widen given strong imports from domestic demand and the lagged impact of easier fiscal and monetary policy, although lower tariffs will help India's exports recover over time.
- Third, other key factors weighing on portfolio inflows into India have not changed, including continued valuation premium, lower relative EPS growth, lack of AI plays in India versus other markets, and on the bond market side higher gross borrowing needs by the central and state governments. As such, while foreign equity portfolio inflows will get a near term pop, we don't think it will be a sustained improvement over 2026. Last but not least, we think RBI has an incentive to buy Dollars given the sizeable net short forward position, and as such there will be some natural floor to USD/INR if inflows improve over time.
- For the INR rates market, we think a trade deal further reduces the chance of a RBI rate cut, and are biased to see INR bond yields to move higher over time given the slower pace of fiscal consolidation and higher government borrowing needs from the recent Budget FY2026/27. We could see some compression in FX forward premia as inflows improve near term, but our best guess is that liquidity will still be a constraint through 2026 and RBI will still have to over time inject more INR liquidity through OMOs to cap INR yields from heading higher.
- Overall, we tentatively adjust our forecasts and target USD/INR at 89.50 in 1Q2026 and 93.00 by 4Q2026 (from 91.50 and 94.00 previously).
- We now see INR 10 year bond yields rising and grinding higher towards 7% by 4Q2026 (from our previous forecast of 6.80%).
- We continue to see RBI keeping rates on hold at 5.25%, and see FX forward premia remaining elevated (but less so than before).
