The year 2025 proved to be a pivotal moment for the global economy, marked by significant policy shifts in Western nations that reverberated across international markets. India, as the world’s fourth-largest economy and a crucial player in global trade, wasn’t shielded from these changes. Despite facing external pressures like escalating tariffs and fluctuating capital flows, India demonstrated remarkable resilience, underpinned by robust domestic demand and strategic policy reforms. This article examines how India navigated these challenges and positioned itself for sustained growth, culminating in a historic sovereign rating upgrade.
Navigating Global Headwinds: India’s Economic Performance in 2025
Policy overhauls in trade, investment, and industrial strategy across Western economies created ripple effects felt worldwide. India, deeply integrated into global value chains, experienced these as external shocks. However, the nation’s economic performance throughout 2025 showcased a surprising degree of stability, largely due to a deliberate focus on internal strengths. Remarkably, average inflation remained low at 1.8% throughout the fiscal year, providing a solid foundation for economic activity.
The key to India’s success lay in a carefully orchestrated series of fiscal, monetary, and trade reforms designed to both mitigate external vulnerabilities and bolster domestic fundamentals. This proactive approach ultimately led to a significant milestone: in August 2025, S&P upgraded India’s sovereign rating from BBB– to BBB – the first such upgrade in 18 years.
India’s Domestic Demand Resilience: A Key Growth Driver
India’s economic expansion in 2025 was primarily fueled by its resilient domestic demand. The economy grew by 8.2% year-over-year in the second quarter of fiscal 2025-2026, reinforcing expectations of a substantial upward revision to full-year growth forecasts. Despite global headwinds, including increased US tariffs and volatile capital outflows, India achieved an impressive 8% growth in the first half of the fiscal year. This growth was powered by strong private consumption and investment, aided by easing inflation and favorable conditions in rural areas.
Key Components of Domestic Demand
- Consumption: Private final consumption expenditure increased by 7.9% in the second quarter, supported by the lowest inflation in a decade (1.7%), rising disposable incomes from tax and GST relief, and a good monsoon season. Overall consumption grew by 7.5% in the first half of the fiscal year.
- Investment: Government capital expenditure utilization rose significantly to 51.8% (compared to 37.3% the previous year), driving growth in gross fixed capital formation to 7.6%.
- Sectoral Strength: Gross Value Added (GVA) grew by 8.1% in the second quarter, with manufacturing up 9.1% and services surging 9.2%, led by the financial and professional services sectors. Services now contribute 60% of GVA and 48% of exports, highlighting their increasing strategic importance.
- Exports: While exports moderated in the second quarter due to higher US tariffs, a rebound is anticipated with upcoming trade agreements with the United States and the European Union, alongside diversification into services, electronics, and pharmaceuticals.
Growth momentum in the third quarter is expected to remain strong, supported by positive high-frequency indicators like consumer confidence, vehicle sales, and easing inflationary pressures. However, external factors like currency depreciation and foreign portfolio investment (FPI) outflows pose downside risks.
Strategic Policy Reforms for Sustainable Growth
At the beginning of 2025, India was in a relatively stable macroeconomic position, with tapering inflation, a consolidating fiscal deficit, and stable growth levels. However, policymakers recognized the potential for economic strain as global political and economic relationships rapidly evolved, impacting export prospects and real incomes. They understood that stimulating domestic demand would be crucial if external demand weakened further.
Fiscal Policy Measures
The Union Budget 2025-2026 signaled a commitment to bold intent, focusing on targeted relief for the middle-income class, which was facing pressure from inflation, a slow post-COVID labor market recovery, and high borrowing costs. Direct tax exemptions were introduced to boost disposable incomes and encourage discretionary spending.
In response to increased US tariffs, the government accelerated the rationalization of GST slabs to stimulate domestic demand, aid the informal sector, strengthen tax compliance, and increase consumer spending. High public capital expenditure, particularly in infrastructure and green-transition projects, remained a central pillar of growth.
Disciplined expenditure management and strong revenue streams allowed the government to maintain fiscal prudence, targeting a fiscal deficit of 4.4% of GDP for the fiscal year, down from pandemic highs.
Monetary Policy and Capital Flows
The Reserve Bank of India (RBI) aligned with the government’s focus on strengthening domestic demand. While fiscal policy aimed to boost consumer spending, monetary policy provided liquidity and cost-of-capital support. The RBI implemented one of the sharpest easing cycles in recent history, cutting policy rates by a full percentage point within four months.
However, despite these efforts, credit expansion remained subdued, prompting the RBI to deliver an additional 25-basis-point rate cut. This signaled a continued commitment to sustaining domestic demand amid global uncertainty.
The narrowing India-US policy rate differential raised concerns about potential capital outflows. In 2025, India experienced significant FPI outflows, totaling US$18.4 billion as of December 12th – the highest in 15 years. This contributed to currency depreciation, with the Indian rupee crossing the 90 rupees per US dollar mark. While the RBI intervened to stabilize the currency, persistent outflows and rising outbound foreign investment could continue to pressure foreign exchange reserves. Fortunately, strong retail participation in the capital market helped stabilize valuations despite foreign investment outflows.
Looking Ahead: India’s Growth Trajectory in 2026 and Beyond
As India enters 2026, several themes will shape the next phase of growth. Full fiscal year growth is expected to be revised upward, driven by strong third-quarter numbers fueled by festive spending. Growth is projected to be between 7.5% and 7.8% in fiscal 2025-2026, and between 6.6% and 6.9% in fiscal 2026-2027, supported by the rollout of new GST rules and continued slowing inflation. Maintaining the same level of pragmatism and proactive policy-making will be crucial to navigate potential challenges and capitalize on emerging opportunities. The success of India’s economic strategy in 2025 provides a strong foundation for continued growth and development in the years to come, solidifying its position as a major global economic power.