20 February 2026

As long ago as my 2019 blog “India: Long Growth Runway Ahead”, I outlined why India’s economy and financial markets would outperform China in the coming decade. And, indeed, India has enjoyed the strongest GDP growth amongst all major economies during the past 10 years (Chart below). As a result, India became a stellar performer amongst Emerging Markets.

However, as India has been a key target of Trump 2.0’s aggressive trade policy, the Indian markets have lagged significantly during the past 18 months. In addition, despite India’s impressive recent economic performance, the nation has been unable to replicate China’s 10% GDP growth of previous decades.

I will address key questions. First of all, can India cope with the near-term risks posed by the Trump Administration’s trade policy? Perhaps more importantly, can India unlock its long-term growth potential, match China’s previous remarkable double-digit growth trend, and achieve its ambition of becoming an advanced global economy? Much may depend on whether it can continue to successfully juggle the complex interactions between the USA, China, and Russia. Following America’s recent decision to reduce Indian tariffs from 50% to 18%, I believe Indian markets will again outperform. I have been advocating overweight EM positions, especially those will large domestic markets that can offset the impact of US tariffs. India ticks the boxes.

Coping with Trump 2.0 Tariffs

Following the recent reduction in US tariffs, I expect India will cope better than other Asian nations. Indeed, the Chart above illustrates exports to the USA as a percent of GDP are far lower than in neighbouring countries. And, despite the high tariffs, India’s exports to the USA advanced 10% in 2025. In addition, India is less reliant on foreign trade compared to other Asian economies. Exports of goods and services account for only 20% of GDP — less than half that of Malaysia, Thailand, Korea, and Taiwan. Furthermore, tariffs are only applied on goods, but over 50% of India’s sales abroad are in services.

To be sure, the USA is India’s largest single trading partner. However, India’s foreign trade is quite diversified (Chart above). In addition, like other countries who view America as an increasingly unreliable partner, India is strengthening economic ties with other countries. Indeed, recently India has signed important trade deals with the European Union, UK, Australia, and New Zealand. At present, as India’s intra-Asian trade is well below its potential, improving regional ties represents an enormous opportunity.

Juggling Global Geo-Politics

India has long experience juggling global great power politics. They’ll need it. In principle, the reduction in US tariffs is contingent upon ending the importation of Russian oil. Since the beginning of the Ukraine War, the share of Russian imports has risen from 1% to 8%, and Russia is now India’s largest source of foreign petroleum. Of course, the US rightly has found this unacceptable. As a positive start, imports from Russia declined 10% in 2025.

Likewise, India has been reducing successfully its reliance on Russian military weapons. France has been the beneficiary so far (Chart above). The USA could have a larger role to play in both energy and weapons sales to India.

Since global trade tensions escalated in 2018, India’s trade with China has expanded. However, reflecting China’s beggar-thy-neighbour trade strategy, Indian exports to China (including HK) have actually declined during the period (sales to the Mainland did rise 13%). Meanwhile, imports from China have soared 70%. As a result, India’s bilateral deficit has double since 2018. Eventually, this could become a source of political friction. In contrast, Indian exports to the USA rose 70% during this interval.

Coping With Tariffs: Robust Domestic Demand

To be sure, the external sector was a drag on Indian GDP growth in 2025. However, overall GDP was resilient, as domestic demand remained bouyant (Chart above). In particular, rising real incomes, tax cuts, and the simplification of the General Sales Tax has resulted in robust gains in private consumption. Meanwhile, business investment has contributed strongly to GDP growth (Chart above) — although I’ll discuss how capex must play a larger role if India aspires to become an advanced economy. Overall, India’s enormous and bouyant domestic economy should continue to offset ongoing global trade risks.

Improving Monetary and Fiscal Credibility

To be sure, the Reserve Bank of India (RBI) does not enjoy full independence from the government. However, the central bank has strenghened its operational autonomy in recent years. And, the adoption of an inflation target in 2016 has boosted further the credibility of monetary policy decision making. Despite robust economic growth, inflation likely to remain in the bottom half of the 2%-6% target zone in 2026. Consequently, the RBI has scope to lower interest rates another 100bp this year.

Historically, large deficits and rising public sector debt often undermined investor confidence in Indian macroeconomic policymaking. In recent years, however, this has begun to change. To be sure, overall goverment deficts remain near 7% of GDP. However, as a result of strong economic growth, debt as a percent of GDP has been declining consistently since 2020 (Chart above). Moreover, India intends to reduce the central goverment’s deficit further; with the goal of lowering CG debt towards 50% of GDP by 2030/31 (from 56% at present).

However, the need for large-scale investments in health, education, infrastructure, and climate-mitigation will make these goals challenging. However, the level of Indian taxation is low relative to many developing economies (Chart above); therefore, mobilising fiscal revenues will be crucial to realising the nation’s long-term GDP potential. In addition, untamed deficits at the state level may jeoparise debt-stabilisation efforts.

Achieving the Economy’s Long-Term Potential

Of course, a full analysis of what’s needed for India to achieve its goal of becoming an advanced economy is beyond the scope of this blog. However, I will highlight key ingredients, which may impact investors’ decisions.

Labour Supply and Poverty Reduction

As in China 20 years ago, the share of jobs in India’s rural areas is the highest amongst EM nations (Chart above). And, the Chart below illustrates the proportion of the population below 25 years old is amongst the lowest in the EM universe (sub-Saharan Africa is an exception).

This presents both opportunities and challenges. The vast number of poor, low productivity agriculture workers represents an endless labour supply for the economy. India has succeeded in lowering poverty in recent decades, but it remains elevated compared to other medium-income EM nations (next Chart). The challenge to producing stronger and inclusive growth lies in improving agricultural productivity to free workers for higher paying manufacturing and service sector jobs. India’s low unemployment rate indicates they are off to a good start (although the level of underemployment is much higher).

Productivity: The Key to Inclusive Growth

Productivity growth is the surest way to produce economic growth, improve living standards, and reduce poverty. To be sure, Indian output per hour is low. Fortunately, however, while much of the world has experienced slower efficiency improvements in the past 20 years, overall Indian productivity has been growing strongly (next Chart).

Unfortunately, the service sector accounts for much of the improvement. Indeed, agricultural productivity remains poor, and manufacturing efficiency has slipped in recent years. To produce inclusive growth, broad-based productivity improvements are needed. In the manufacturing sector, especially, low levels of R&D have contributed to recent poor efficiency performance (Chart below). Business investment and R&D tends to be concentrated in larger firms. But, 85% of Indian enterprises employ less than 10 people, larger firms invest more, are more productive, and are best able to exploit economies of scale. Therefore, bureaucratic and other impediments to scaling up enterprises should be reduced.

Improving the Business Climate for Investment

Deregulation is critical to improving the business climate and fostering greater local investment. As just one example, both exporters and importers complain of suffocating red tape. As a result, exports as a percent of GDP are lower than Asian peers, and Indian firms are not in a position to exploit global supply chains (next Chart).

As nations look to diversify their trade and investment partners away from the USA, India’s low costs and large domestic market could make it an especially attractive destination. However, not only has over-regulation impeded trade growth, FDI inflows into India lag other large EM alternatives (next Chart).

Strategic Considerations

• Indian GDP should expand 7%-8% in the year ahead. However, successful reforms could boost growth towards China-style 9%-10% growth over the medium term.

• Inflation will remain in the 2-4% range in 2026. As real interest rates remain high, the RBI will have scope to lower another 100bp (next Chart).

• To be sure, Indian equities are not cheap. However, recent underperformance has improved valuations (next Chart). Strong growth, low inflation and declining interest rates should support stocks. However, the global sell-off in tech stocks, particulary software, is a concern. Nevertheless, I would begin to scale back into Indian equities.

• In recent years, the RBI has sought to maintain export competitiveness by allowing the rupee to depreciate to offset India’s higher inflation. Last year, however, the RBI allowed the INR to decline sharply to offset the impact of higher tariffs. Consequently, INR is now undervalued (Chart below). With tariffs reduced and inflation low, the pace of INR depreciation should be more modest in 2026.