• India’s severe COVID-19 crisis is adversely impacting the country’s current economic recovery momentum and outlook.
  • Domestic demand rebound is dampened by virus developments; India’s relatively weak public finances prevent further meaningful fiscal stimulus.
  • Indian exporters are benefiting from recuperating global demand, yet the external sector plays a smaller role in India’s economy compared to other nations in the region.
  • India’s inflation outlook is surrounded by notable uncertainties, likely preventing the Reserve Bank of India from providing further monetary stimulus to the economy.


India’s promising economic recovery prospects have recently turned more precarious as the country’s COVID-19 situation has worsened significantly in recent weeks (chart 1). India now accounts for most of the new infections globally, putting the country’s health care system under extreme stress. The virus surge is posing significant downside risks to India’s economic outlook. In the fourth quarter of 2020, India’s real GDP growth returned to positive territory with output increasing by 0.4% y/y. We expect the economy to continue to regain momentum on a year-over-year basis—largely due to base effects—yet at a slower pace than it would have without the strong second wave of COVID-19 infections. We expect India’s real GDP to expand by 9.3% in 2021 and 7.0% in 2022; last year, output contracted by 7.1%.

The evolving COVID-19 situation and the speed of the country’s vaccination program will be the key factors driving the outlook for private spending. Despite weak consumer confidence (chart 2), household outlays have been picking up, yet they are expected to face a period of softness that will likely persist in the near future. Meanwhile, the approaching southwest monsoon season (June-September) will have a large impact on rural incomes as around 60% of the country’s agricultural land is rainfed; the India Meteorological Department expects monsoon rainfall to be normal this year, which brightens the outlook for rural demand. We expect India’s fixed investment to recover only gradually over the coming quarters. The government’s investment incentives and lending schemes will provide some support to private sector business investment, yet activity is expected to be weighed down by the uncertain business environment amidst the pandemic and stress in banks’ balance sheets.

India’s export sector is boosted by stronger global trade activity, which is reflected in sentiment and industrial output (chart 3). Even though the economy is more driven by domestic demand when compared to its regional export-oriented peers, the re-opening of the US and the European Union economies will be underpinning India’s external sector performance; the two economies purchase over 30% of India’s shipments abroad.

As per the Union Budget for Fiscal Year 2021–22 (April–March) unveiled in February, India’s fiscal policy stance will be growth-supportive. The Budget will also improve the country’s longer-term growth potential given increased outlays on healthcare, infrastructure, and education. The government aims to resume fiscal consolidation efforts and narrow the fiscal deficit from the estimated 9.5% of GDP recorded for FY2020–22 to a projected 6.8% of GDP in the current fiscal year and further to 4.5% by FY2025–26. While the administration is prioritizing the economy’s recovery, it is simultaneously trying to show commitment to fiscal prudence over the medium-term in order to support investor confidence. We assess that India’s relatively weak public finances will limit the government‘s ability to provide meaningful support to the economy at this stage of the health crisis. Simultaneously, we do not foresee an improvement in India’s public finances this year on the back of the adverse impact on the economy and on the government’s revenue caused by the pandemic. Indeed, downward pressure on India’s public finances has prompted Moody’s and Fitch Ratings to assign a “negative” outlook to India’s sovereign credit ratings; we assess that continued fiscal slippage would likely prompt rating downgrades.


India’s inflation dynamics have been volatile in recent months (chart 4), mostly reflecting year-ago base effects and sharp changes in food prices. In April, headline inflation eased to 4.3% y/y, thereby returning towards the mid-point of the Reserve Bank of India’s (RBI) 2–6% inflation target range. Meanwhile, core inflation—CPI inflation excluding food and fuel—remained elevated at 5.2% y/y in April on the back of stronger pass-through from higher commodity prices, increased fuel and other taxes, and firms’ elevated operating costs.

With food being a significant part of the Indian consumption basket and the southwest monsoon rainfall having a large impact on food prices, the country’s inflation outlook is surrounded by significant uncertainty. Moreover, higher commodity prices and price pressures resulting from supply chain disruptions add to the inflation concerns. We estimate that India’s headline inflation rate will rebound to above 5% y/y over the next few months before easing to 4.7% by the end of the year. In 2022, price pressures are expected to strengthen once again with inflation hovering slightly above 5% y/y throughout the year.

India’s monetary policy conditions will likely remain loose over the coming months despite the uncertain inflation outlook. The Reserve Bank of India (RBI) held its latest monetary policy meeting on April 5–7 and maintained its accommodative policy stance, pointing out that it would be continued as long as necessary to revive growth on a durable basis. The RBI has also pledged to continue providing ample liquidity to the economy through various facilities. The RBI reduced the benchmark repurchase rate by 115 bps over the course of 2020; we expect the policy rate to be left at the current level of 4.0% through 2021. As demand conditions normalize and price pressures remain persistently in the upper end of the RBI’s inflation target range, the central bank will likely start raising the policy rate gradually in early 2022. We forecast a hike of 25 bps in each quarter, taking the policy rate to 5.0% by the end of 2022.

Should India’s COVID-19 crisis show clear signs of improvement over the coming weeks, the Indian rupee (INR) would likely face a mild appreciating pressure against the US dollar (USD). Meanwhile, changes in global risk aversion, volatile appetite toward emerging market assets, as well as shifting expectations regarding the US monetary policy normalization will be reflected in the value of the rupee (chart 5). Once the country’s COVID-19 wave abates and the economy gets back on its feet, the INR outlook is set to improve. We expect USDINR to close the year at 72.


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