India mid-term outlook: domestic demand supports growth, while oil prices and external shocks weaken stability

Overview

This report is Morgan Stanley’s medium-term outlook for the Indian economy. The core view is that India’s growth remains resilient in the near term despite geopolitical conflicts, higher oil prices, and external-demand uncertainty, but macro stability will deteriorate marginally. The report expects the shock to be most visible in QE Jun-26, after which growth gradually returns to pre-conflict levels as supply constraints ease and commodity prices fall.

Core views

The report expects India’s growth to continue relying on domestic demand. Private consumption accounts for about 57% of GDP and remains the main support; public capex is being driven by central government infrastructure and defense spending, while private capex is gradually improving in power, semiconductors, data centers, and electronics. On the external side, goods exports are under pressure, but services exports remain resilient. On macro stability, F2027 CPI is expected to rise to 4.7%, the current account deficit is expected to widen to 1.8% of GDP, and the balance of payments could post a deficit for the third consecutive year. On policy, fiscal policy will serve as the first line of defense, while monetary policy will likely pause rate hikes in F2027 and use non-rate measures to manage FX and capital-flow pressure.

Analysis framework

The report analyzes the macro framework across growth, consumption, investment, exports, inflation, the current account, fiscal policy, and monetary policy, and compares India’s growth, inflation, current account, and policy-rate paths under a base-oil-price scenario and a high-oil-price stress scenario.

Methodology notes

• Macroeconomic forecastingBase-case scenario forecast

  Uses Brent F2027 average of US$87.5/bbl and F2028 average of US$80/bbl as the base case to forecast GDP, CPI, current account deficit, and policy rates.

  This framework is used to assess the main impact of supply shocks on growth and stability and to provide the macro path for F2026-F2028.

• Scenario analysisHigh-oil-price stress scenario

  Assumes oil prices stay around US$110/bbl in F2027 and measures the nonlinear impact on growth, inflation, and the current account.

  This scenario shows GDP growth could fall to 6.2%, CPI could rise to 5.4%, and the current account deficit could widen to about 3.0% of GDP.

• Policy responseCountercyclical policy assessment

  Evaluates how fiscal spending, subsidies, fuel taxes, non-rate monetary tools, and the future rate-hike path buffer the shock.

  The report argues that fiscal policy will first absorb the shock and protect capex, while the RBI is more likely to use non-rate tools first and only enter a shallow hiking cycle in F2028.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• India macro growth

  Core research subject

  Strengths

  Resilient domestic demand, with support from consumption, government capex, and services exports.

  Weaknesses

  Weaker external demand, rising oil prices, and supply-chain frictions weigh on near-term growth.

  Comparison

  F2027 growth is expected to slow from 7.6% in F2026E to 6.7%, then recover to 7.0% in F2028.

  Risks

  A global growth slowdown, elevated commodity prices, and unfavorable progress on the India-US trade agreement.

• INR and external accounts

  Transmission channel for macro stability risk

  Strengths

  Foreign exchange reserves and import coverage remain healthy, and the external-debt structure is manageable.

  Weaknesses

  The widening current account deficit and weak capital inflows mean the balance of payments could post a deficit for a third straight year.

  Comparison

  In the base case, F2027 CAD is 1.8% of GDP; in the high-oil-price scenario it widens to about 3.0%.

  Risks

  Every 10% rise in oil and gas prices could widen CAD by 30-35 bp of GDP and increase currency vulnerability.

• India rates

  Policy-response asset

  Strengths

  The RBI is expected to stay on hold in F2027, helping cushion the growth shock.

  Weaknesses

  If inflation stays above 5% while growth remains resilient, F2028 may enter a shallow hiking cycle.

  Comparison

  In the base case, the policy rate is 5.25% at F2027 year-end and 5.75% at F2028 year-end.

  Risks

  A high-oil-price scenario could push the RBI to tighten earlier, before QE Dec-26.

• India capex chain

  Beneficiary of domestic-demand and policy support

  Strengths

  Central government capex, infrastructure, and defense spending support public investment, while private investment is improving in power, semiconductors, data centers, and electronics.

  Weaknesses

  Private capex is still concentrated and remains more dependent on project execution than on a broad-based recovery.

  Comparison

  Central government capex in F2027 is expected to grow 11.5% YoY, while infrastructure-related spending rises 14%.

  Risks

  Higher costs, fiscal-deficit pressure, and external uncertainty may slow execution.

• India consumption

  The main pillar of GDP growth

  Strengths

  Improving employment conditions, retail credit, and automobile sales continue to support consumption.

  Weaknesses

  Rural consumer confidence is softening at the margin, and weak monsoons plus agricultural-input supply issues may affect farm incomes.

  Comparison

  Private consumption growth on a QE Dec-25 four-quarter trailing basis was 7.9% YoY, above 5.9% in QE Dec-24.

  Risks

  Second-round inflation effects, slowing incomes, and oil-price shocks could weaken purchasing power.

Key data

• F2027 real GDP growth forecast6.7% YoYBase case; down from 7.6% in F2026E and expected to recover to 7.0% in F2028E.
• F2027 CPI forecast4.7% YoYAffected by production costs, INR weakness, and passthrough from core inflation.
• F2027 current account deficit forecast1.8% of GDPAssumes Brent averages US$87.5/bbl.
• F2027 year-end policy rate forecast5.25%The RBI is expected to stay on hold in F2027; year-end F2028 rises to 5.75%.
• High-oil-price scenario F2027 GDP6.2% YoYAssumes oil prices around US$110/bbl, about 50 bp below the base case.
• High-oil-price scenario F2027 CPI5.4% YoYInflation could remain above 5% for four consecutive quarters.
• High-oil-price scenario F2027 current account deficit3.0% of GDPWould be significantly above the policy comfort zone.
• Private consumption as a share of GDPAbout 57%The core anchor of India’s domestic-demand narrative.
• F2025 goods exportsUS$426bn, 11.8% of GDPGoods export growth is relatively weak.
• F2025 services exportsUS$372bn, 10.3% of GDPServices export growth remains strong and partially offsets pressure on goods exports.

Impact & implications

For asset allocation, India’s macro fundamentals still show growth resilience, but higher oil prices, a deteriorating current account, and weak capital flows will add pressure to the INR and local financial conditions. Consumption and manufacturing remain supported by domestic demand, but downstream sector margins may be squeezed by input-cost pressure. Prioritizing capex protection is positive for infrastructure, defense, and related investment chains, but higher subsidies and weak revenue may create fiscal-deficit slippage.

Risks

• If global commodity prices, especially crude oil, remain elevated, they will create stagflationary pressure.
• A global growth slowdown could weaken India’s external demand and goods exports.
• Weak capital flows, a stronger dollar, and tighter global financial conditions could intensify pressure on the INR.
• If the India-US trade agreement is delayed or turns unfavorable, it could hurt trade and investment sentiment.
• Weak monsoons, El Nino, and input-supply issues such as seeds and fertilizers could affect agricultural output and rural income.
• Rising subsidies and weak revenue may widen the F2027 fiscal deficit by about 0.3-0.5 percentage points versus the 4.3% budget target.

What to watch

• Whether growth bottoms around 6.5% in QE Jun-26, as the report expects.
• Whether Brent oil prices peak and then ease in QE Jun-26 under the base case.
• Whether second-round CPI effects and food inflation exceed expectations.
• Whether the current account deficit, capital inflows, and the balance of payments continue to deteriorate.
• Whether the RBI continues to stay on hold and shifts to non-rate tools such as ODI rules, NRI deposits, and FX inflows.
• Execution rates of central and state government capex, especially infrastructure, defense, and SASCI-related outlays.
• Whether services exports can continue offsetting weakness in goods exports.