For the Indian economy, 2025 turned out to be an unexpectedly benign — even enviable — year. At a time of global uncertainty driven by trade wars, geopolitical conflicts, and financial volatility, India found itself in a rare “Goldilocks” phase: growth was strong, inflation unusually low, and external shocks proved less damaging than feared. Yet beneath this comforting surface lay stresses in capital flows and questions about the durability of the recovery.
Three surprises that defined 2025
The first and most striking surprise was growth. GDP expanded by 7.4 per cent and 8.2 per cent in the first two quarters of the fiscal year, well above initial expectations. This momentum forced analysts and institutions to revise India’s growth outlook upwards, reinforcing its position as the fastest-growing major economy.
The second surprise came from inflation. Retail inflation fell to just 0.3 per cent in October — the lowest reading since fiscal 2012. Excluding gold, headline inflation slipped into negative territory, reflecting benign food prices, easing supply constraints, and policy credibility.
The third surprise was global. Despite steep tariffs imposed by the United States and record-high uncertainty, the global economy held up far better than anticipated. The International Monetary Fund revised its 2025 global growth estimate upward by 40 basis points to 3.2 per cent, softening fears of a synchronised slowdown.
AI boom reshapes global and Indian prospects
As the year progressed, pessimism around tariffs gave way to optimism driven by massive investments in artificial intelligence, particularly in the United States. The AI-led surge boosted demand for high-tech hardware, semiconductors, and digital services, benefiting several Asian and European economies.
This wave of investment, along with frontloading of exports ahead of tariff rollouts, prompted the World Trade Organisation to sharply raise its forecast for global merchandise trade growth in 2025 from 0.9 per cent to 2.4 per cent. India, while not at the centre of the AI boom, benefited indirectly through improved global demand and technology spillovers.
Capital flows: the weak spot in an otherwise strong year
Despite strong macro fundamentals, capital inflows into India were volatile. The rupee depreciated sharply, emerging as the worst-performing currency among major emerging markets. Net foreign institutional investment remained negative in equities and tepid in debt, while foreign direct investment stayed subdued through much of the year.
Unlike the 2013 “taper tantrum”, when India was labelled part of the “fragile five” due to twin deficits and high inflation, the current episode reflected stress largely on the capital account. The current account deficit remained below 1 per cent of GDP, fiscal parameters were stable, and inflation was low. However, India faced among the highest US tariffs, dampening investor sentiment, while global capital gravitated towards the US to finance its AI-led investment cycle.
Policy support cushions external shocks
Two factors beyond India’s control provided timely relief: a favourable monsoon and low crude oil prices. Together, they eased inflationary pressures and supported rural incomes. Complementing this was proactive policy action.
On the fiscal side, the government frontloaded capital expenditure, rationalised Goods and Services Tax rates mid-year, and complemented budgeted income tax cuts. Large-scale direct benefit transfers to women — estimated at over ₹2 lakh crore — helped sustain consumption during a volatile global phase.
Monetary policy also played a critical role. The Reserve Bank of India, through its Monetary Policy Committee, cut the repo rate by a cumulative 125 basis points in 2025, reduced the cash reserve ratio by 100 basis points, and undertook regulatory easing and open market operations to improve credit transmission and stabilise bond markets.
Outlook: slower growth, changing investment pattern
Looking ahead, growth is expected to moderate to around 6.7 per cent in fiscal 2027, with inflation rising to about 5 per cent, partly due to base effects. Tax revenues should improve with higher nominal GDP growth, but fiscal prudence will constrain the government’s ability to significantly expand public investment.
Encouragingly, there are early signs of a revival in private corporate capex. More importantly, the composition of investment is shifting. Between fiscals 2026 and 2030, production-linked incentive schemes and emerging sectors are expected to account for a quarter of total capital expenditure, up from 12 per cent in the previous five years. Data centres, cloud infrastructure, and AI ecosystems exemplify this transition, with global technology firms committing long-term investments in India.
What to note for Prelims?
- India’s GDP growth rates in early fiscal 2025
- Retail inflation at multi-decade lows
- Repo rate and CRR cuts by the RBI
- IMF and WTO revisions to global growth and trade forecasts
- Role of monsoon and crude oil prices in macro stability
What to note for Mains?
- Explain the concept of a “Goldilocks economy” in the Indian context.
- Analyse why capital flows remained volatile despite strong fundamentals.
- Discuss the role of fiscal and monetary coordination in cushioning external shocks.
- Evaluate how AI-led global growth is reshaping India’s investment landscape.
- Assess the sustainability of India’s growth amid fiscal constraints and global uncertainty.
