MUMBAI: India–US trade policies pose a downside risk to aggregate demand, which is currently holding up due to benign financial conditions, the ongoing transmission of rate cuts, supportive fiscal measures and rising household optimism, the Reserve Bank of India’s monthly State of the Economy report said.
The report noted that the inflation outlook for the near term has become more benign than anticipated earlier, with headline inflation likely to soften further below the 4 per cent target in Q2 before inching up in the last quarter of the financial year. “Overall, the average headline inflation this year is expected to remain significantly below the target,” it said.
On monetary policy, the report said the RBI would continue to maintain a close vigil on incoming data and the evolving growth–inflation dynamics to chart the appropriate policy path.
It further said the sovereign rating upgrade by S&P bodes well for bond markets, enhancing the credibility of monetary policy and potentially lowering borrowing costs. “India’s sovereign rating upgrade by S&P bodes well for capital inflows and sovereign yields, going forward,” the report said.
S&P Global Ratings recently upgraded India’s long-term unsolicited sovereign credit rating to ‘BBB’ from ‘BBB-’, while also raising the short-term rating to ‘A-2’ from ‘A-3’.
“The S&P’s sovereign rating upgrade for India — underpinned by buoyant economic growth, enhanced monetary policy credibility and the government’s commitment to fiscal consolidation — could potentially lead to a reduction in borrowing costs, greater investor confidence and higher foreign capital inflows,” the report said.
Government bond yields initially fell following the upgrade, only to reverse course in the next trading session due to the government’s announcement on rationalising GST rates.
The report cited trade-related issues as a factor behind the hardening of sovereign bond yields. “In the fixed income segment, 10-year G-sec yields hardened during mid-July to early August amidst uncertainties over India–US trade negotiations and subsequent tariff imposition by the US. The S&P’s upgrade of India’s sovereign rating on August 14, 2025 led to a brief easing. Thereafter, yields hardened during the third week of August,” it said.
High-frequency indicators showed a mixed trend in July. “Various high-frequency indicators of domestic economic activity showed a mixed trend in July, with GST e-way bills scaling a record high and GST collections registering robust growth, but electricity demand remained subdued,” the report said.
It observed that rural demand continued to show resilience, supported by the timely progress of the southwest monsoon, which boosted kharif sowing. “An increase in real rural wages may support rural demand in the second half of the financial year,” it said.
Industrial activity remained subdued in June, dragged down by mining and electricity, though lead indicators for manufacturing and services activity pointed to sustained expansion in July.
On the India–US tariff issue, the report said that while current exemptions alleviate the immediate impact, exports in some sectors may still be negatively affected.
The report said overall financial conditions remained benign during July and August (till August 21). Amid surplus liquidity, the weighted average call rate — the operating target of monetary policy — hovered in the lower half of the corridor. Overnight rates in the money market moved in tandem with the weighted average call rate.
It added that net FDI inflows remained muted due to increased repatriation and outward flows, even as gross inward foreign direct investment touched a four-year high in June. “India’s external sector remained resilient with a modest current account deficit and forex reserves covering 11 months of imports,” the report said.
Source: Business Standard
