The ascent of India’s economy

INDIA HAS seldom been a source of economic cheer. The “Hindu rate of growth” is, notoriously, a pace so stubbornly slow it might have been cosmically fixed. Even in recent decades, as India has become the world’s fastest-growing big economy and closes in on being its fourth-largest, it has never matched the pace of Asia’s 20th-century tigers. The goal set by Narendra Modi, the prime minister, of being a developed economy by 2047, the centennial of independence, has seemed far off. The world’s most populous country has remained peripheral to the global economy. But it is now showing remarkable promise.

All the more so, given the headwinds it faces. In August Donald Trump, America’s president, singled India out for a tariff of 50%, combining a 25% “reciprocal” levy with a further 25% as punishment for buying heavily discounted Russian crude oil. Private-sector investment is sluggish. Foreign investors have been selling out of India’s highly valued stockmarket. The rupee slid to a record low against the dollar at the end of last year.

Yet a combination of three things—luck, macroeconomic policy and structural reform—is reason for optimism, in both the short and long term. In the year to the third quarter, GDP grew by 8.2%, much faster than expected. The government has raised its forecast for the 2026 fiscal year (ending on March 31st), which will feed into the budget on February 1st, from a range of 6.3-6.8% to 7.4%. That is the sort of pace that India needs to meet Mr Modi’s 2047 target. Meanwhile, inflation is down to 1.3% (see chart 1). The government boasts of a “Goldilocks moment”.

Consider luck first. In 2025 India enjoyed a second consecutive year of good monsoon rains, boosting agricultural output. Food prices, which make up 46% of the Indian consumer-price index, fell by 2.7% last year, helping drag inflation down. That has boosted real disposable incomes and consumer spending. Low inflation has also given the growth numbers a statistical lift. Because India’s gdp deflator, which is based chiefly on wholesale prices, is thought to have risen by just 0.5% in the year to October, real growth has accelerated as nominal growth has slowed.

Next, macroeconomic policy. A programme of fiscal consolidation has cut the budget deficit from 9.2% of gdp in fiscal 2021 (when it was bloated by pandemic spending) towards a target of 4.4% for fiscal 2026. Excluding interest payments, the deficit will be only around 0.9% of gdp.

This year the government has relaxed the pace, tightening by only around 0.5% of gdp after 1% in fiscal 2025. After Mr Trump announced the additional tariffs, Mr Modi’s government simplified India’s goods-and-services tax, and cut its rates, at an estimated cost of 480bn rupees ($5.3bn) annually. Capital spending on infrastructure was pulled forward. Even so, at the budget the government may reveal it has hit its 4.5% target. It will switch to a more forgiving goal, based on the ratio of debt to GDP. It aims to reduce this to 50% by 2031, from around 56% today.

The Reserve Bank of India (RBI), too, has shifted its stance. Sanjay Malhotra, the governor since December 2024, has been readier than his predecessor to let the rupee depreciate. With inflation under control, interest rates have been cut by 1.25 percentage points over the past year. Mr Malhotra has told the Financial Times that they are likely to stay low for a “long period”. 

Most durable, however, is the third factor, structural reform. The decline in inflation is not just limited to food, points out Sonal Varma of Nomura, a bank. Earlier reforms, such as the creation of a digital-payments infrastructure, which made prices more transparent, as well as the RBI’s shift to an inflation-targeting regime in 2016, have helped reduce inflation expectations and are now paying off. The RBI has also built up its stock of foreign-exchange reserves. A banking sector clean-up and reforms to the bankruptcy code have kept the financial system stable.

The longer term looks even more promising, thanks to a vigorous reform effort aimed at problems that have bedevilled the economy for decades. A long-mooted cut in the number of labour codes, from 29 to four, was enacted in November. A cap of 74% on foreign direct investment in the insurance industry has been lifted. Nuclear power has been opened up to the private sector. Financial-market regulation has been overhauled.

The states have also pursued reforms. Allowing women to work after dark, for instance, means textile and electronics factories can stay open later. An energetic committee led by Rajiv Gauba, formerly a long-serving cabinet secretary, publishes lists of potential reforms for both states and the central government every month.

Unintentionally, Mr Trump has also given India’s reforms a shove. His tariffs quashed hopes that the country would attract manufacturers diversifying supply chains away from China. Mr Trump’s reciprocal tariff on India was higher than on Vietnam or Thailand; the extra 25% made matters worse. India needed a new growth strategy. The tariffs also created the political space for Mr Modi to push through reforms long seen as too difficult.

In fact, Indian exporters have mostly shrugged off the tariffs: exports in December were 1.9% higher than a year earlier; in November they were 19.4% up. Granted, there are signs of suffering in labour-intensive manufacturing: exports of gems were down by 5% in December, and the growth of total exports to America has slowed. However, the damage has been mitigated by the weaker rupee, which has boosted the dollar value of exports, and by diversification—in particular, by India’s growing share of the global electronics market.

Apple now makes around a fifth of all iPhones in India. Phonemakers benefit from “production-linked incentives” (subsidies based on factories’ output) as well as softer forms of government support. Tamil Nadu, a southern state, has been China-like in its fervour to build new industrial towns for workers at Foxconn (the main contract manufacturer of iPhones). At Samsung’s sprawling plant in Noida, near Delhi, workers now make touchscreens and circuit boards themselves rather than assembling kits built elsewhere. The value-added in India’s smartphone manufacturing has risen from around $4.5bn in 2021 to $17.3bn in 2025 (estimated using data from the India Cellular and Electronics Association). It does no harm that electronics are exempt from American tariffs.

Relations with China, which froze after a border skirmish in 2020, have thawed. After clashes in the Galwan Valley, a disputed area of the Himalayas, India suspended visas, investment permissions and direct flights. The countries have now reached a detente, at least on trade, partly in response to Mr Trump’s trade war. In December exports to China were nearly 70% higher than a year earlier (see chart 2). Recognising that India’s ambition to become a global manufacturing hub depends on Chinese expertise and machinery, the government re-liberalised the visa regime, making it easier for Chinese workers to help build Indian factories. It is reported to be mulling allowing Chinese companies to invest in India again.

The government has begun to reverse a trend towards protectionism. The average effective tariff rate crept up from about 13% in 2014 to 18% by 2021, as ministers sought to encourage domestic manufacturing. The rate is now down to 16%. India is not embracing free trade. But it is seeking new export markets via trade deals with rich countries, while reducing barriers to imports of components from other developing markets.

Deals have been signed with Britain, Oman and New Zealand. One with the eu is expected to be announced on January 26th when Ursula von der Leyen, president of the European Commission, will be a guest of honour for a national holiday. Canada and India have said they are working towards an agreement. Relations were strained by the assassination in 2023 of Hardeep Singh Nijjar, a Canadian Sikh activist, but as with China, Mr Trump’s trade war has pushed the two closer. The finance minister, Nirmala Sitharaman, apparently intends to simplify tariffs in next month’s budget. “Customs is my next big cleaning-up assignment,” she said in December.

Meanwhile quality control orders (qco), certifications for every import, nominally to protect consumers and the environment, have been thinned. By early 2024 there were 765. Since mid-2025 the government has been cutting them back, mostly on intermediate goods. They included purified terephthalic acid, an ingredient in polyester, and viscose staple fibre, used in textiles. The qcos boosted the profits of the big industrial houses that dominate domestic production of these inputs, but helped keep garment factories, which provide the sort of low-skilled jobs India desperately needs, uncompetitive.

India’s next test is to convince investors its zeal for reform will last. Corporate capital spending is still soft, despite speedy GDP growth. Net foreign direct investment is negative, as foreigners repatriate profits and Indian conglomerates invest abroad. India’s good luck may continue. But it is better not to rely on monsoon rains, or on America’s Supreme Court striking down Mr Trump’s tariffs. Just as well, then, that India seems to have decided that the risks from trying to transform its economy are less than those of being left behind. ■