With US President Donald Trump’s reciprocal tariff announcement leading to trade tensions globally, Morgan Stanley said that these will likely remain a drag on Asia’s growth outlook while highlighting that ‘India is still best placed in the region’. Factors like low goods exports, strong services exports and policy support for domestic demand, will work in favour of India.
However, so far, the bounce in growth has been still somewhat softer than expected, and the longer this continues, the more it will fuel skepticism. So how long will it be before we get meaningful signs of a recovery? What will drive the recovery? What can drive consumption and investment growth going forward? Will trade tensions affect India’s growth outlook? Morgan Stanley addressed these key concerns. “In the event of a sharper slowdown in global trade, India will also be a relative outperformer considering: (1) its goods exports to GDP are the lowest in the region and (2) its services exports tend to be more defensive with an offset from continued gains in market share,” the brokerage firm stated.
What caused the growth slowdown?
Morgan Stanley attributed the slowdown that happened in India to an unexpected double tightening of fiscal and monetary policy, even though macro stability indicators were not flashing red. “Government spending – which accounts for 28 per cent of GDP – contracted by 6 pr cent at the trough in Jul-24 on a three-month trailing basis amid elections, and then recovered at a slower-than-expected pace post-elections, especially on the capital expenditure front (which averaged 12 per cent in May-Nov 24 but has now recovered to 37 per cent 3MMA in Jan-25). Monetary policy was tightened on all three fronts of policy rates, liquidity and regulatory measures,” said Chetan Kishore Ahya, Chief Asia Economist, Morgan Stanley.
What will drive the recovery?
With green shoots already emerging in recent data, Morgan Stanley said that the recovery will continue to firm over the coming months. The brokerage firm’s high frequency metric, GST revenue, accelerated to an average of 10.7 per cent in Jan-Feb 2025 compared with an average of 8.9 per cent in 3Q24 and 8.3 per cent in 4Q24.
“We believe the recovery will be driven by 1) sustained momentum in government capex spending, 2) triple easing on monetary policy, 3) moderation in food inflation lifting real household incomes, and 4) improvement in services exports,” said Chetan Kishore Ahya.
a) Government capex spending: Government capital expenditure growth has accelerated in December and January, the analyst report stated. In the FY2026 budget plan, capital expenditure is estimated to grow at 10.1 per cent indicating continued support for public capex.
b) Monetary policy – Easing on three fronts: Morgan Stanley said that policy easing is expected to ease across policy rates, liquidity and regulatory front to support the growth recovery. Most of these measures have been taken up only in the past six weeks or so and so there will still be some time before it fully filters through in terms of supporting the recovery, it said.
• Policy rates: The RBI, in February, cut repo rate by 25 bps to 6.25 per cent from 6.50 per cent. Real policy rate on core inflation has now moderated by 90 bps to 2.5 per cent in Feb-25. “We expect a second 25 bps rate cut at the April meeting with risks of more rate cuts if the growth recovery plays out more slowly than we expect,” Chetan Kishore Ahya said.
• Liquidity conditions: With RBI now returning to a more flexible FX regime since December and taking up a suite of measures to inject liquidity including OMO purchases, variable rate repos, and USD/INR swaps, weighted average call rate on a 14-day average basis has now declined by 43 bps from end-December levels and is tracking below the repo rate. “Our India economics team expects RBI to continue to manage liquidity conditions proactively, especially in the context of the seasonal rise in liquidity deficit towards financial year end (March),” Morgan Stanley report stated.
• Regulatory changes: The RBI has begun easing regulatory tightening on non-bank financial companies (NBFCs) – as evident in the recent rollback of the 25ppt increase in risk weights for bank credit to NBFCs – Morgan Stanley’s India financials analyst Subramanian Iyer said that this might help improve liquidity accessibility for NBFC lenders and end borrowers.
c) Food inflation decline improving real incomes: With food inflation moderating from its October peak of 10.9 per cent to 6 per cent in January, headline CPI has taken a step down to a five-month low of 4.3 per cent. With the trend in high frequency food prices indicating continued percentage moderation in February and March month-to-date, Morgan Stanley predicted the disinflation trend at the headline CPI level to continue, with headline inflation averaging 4.8 per cent in 1H25 and 3.9 per cent in 2H25. “This should translate into higher real incomes for households, providing support to consumption recovery,” it said.
d) Strength in services exports: India’s services exports have now close to doubled since Dec-20, outpacing the 41 per cent rise in goods exports over the same time period. This has meant that services exports have now reached $414 billion on a three-month trailing sum annualized basis in January (10.8 per cent of GDP), close in size to the $426 billion of goods exports. This, Morgan Stanley said, also echoes the global trend of a sharper rise in services exports than goods exports since Covid.
While goods exports excluding oil have also been recovering in the last four months, the brokerage firm said that this would potentially be facing headwinds as tariff uncertainty weighs on corporate confidence, capex and the trade cycle.
“During times when the global trade environment turns down, goods exports may contract but services generally do not. Moreover, there is now added momentum from a rise in market share in an environment where digitalization is expanding the addressable market. This strength in services exports should also reflect in a pickup in urban jobs growth and hence private consumption with a lag,” Chetan Kishore Ahya said.
Outlook for capex
Combined central and state government overall expenditure growth has now stabilized at 9 per cent in 4Q24 after tracking at an average of 4 per cent in 2Q-3Q24. Importantly, the analyst report said, central government capital expenditure growth has picked up pace in recent months. In the FY26 Budget, policymakers have budgeted for stronger central government capital expenditure growth to 10.1 per cent (vs a revised 7.4 per cent for FY25).
Morgan Stanley said, “The next phase of the public capex recovery will be driven more by the state governments, we believe.”
On the other hand, recovery is expected in private capex to remain slow. The analyst report stated, “As we have been highlighting, the backdrop of heightened global uncertainty would likely weigh on Asia’s capex and trade cycle. For India, the resultant slowdown in goods exports would also weigh on manufacturing sector capex trends. To be sure, we believe India could be less exposed given lower goods trade orientation than other Asian economies, and the fact that monetary policy easing across policy rate, liquidity and regulations should provide some floor for private capex.”
Can India reach a trade deal?
While India is exposed to direct tariff risks, Morgan Stanley said, India is less exposed to global goods trade slowdown considering that it has the lowest goods exports to GDP ratio in the region.
From a tariff risk perspective, India is among the more exposed economies to further tariff escalation within Asia given India imposes very high tariff rates on select imports, existence of high non-tariff barriers and the size of its goods trade surplus with the US.
While India is expected to eventually reach a trade deal with the US, Morgan Stanley believes that it would be relatively more challenging given the multiple bilateral trade issues. As it is, officials have guided for a Fall 2025 timeline for a possible US-India free trade agreement. This would imply that India would not be able to avoid reciprocal tariffs scheduled for April 2nd and that tariffs could likely go up in the meantime until at least the trade deal is reached.
While India is exposed to direct tariff risks, Morgan Stanley has highlighted that the bigger effect on growth from tariffs likely comes via the indirect transmission channel of weaker corporate confidence from heightened policy uncertainty and the spillovers to capex and trade cycle.