India File: Plot twists of last year will also define 2026

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Jan 6 - By Ira Dugal, Editor Financial News, with global Reuters staff

Happy 2026!

Three big surprises shaped India in 2025. A stalled trade deal with the U.S., an economy that outdid even the optimists, and a stock market that suffered its worst relative performance in decades.

How will these play out in 2026? That's our focus this week. Write to us at ira.dugal@thomsonreuters.com to share your views on key questions going into the new year.

And scroll down for the latest in a Reuters special series on India's water crisis.

THIS WEEK IN ASIA

**US capture of Maduro tests limits of China's diplomatic push

**Bank of Japan chief vows to keep raising interest rates

**Samsung to double mobile devices powered by Google's Gemini to 800 mln units this year

**China, Pakistan reaffirm ties as US outreach to Islamabad deepens

WAITING ON A US TRADE DEAL

The year begins with a question that vexed analysts, forecasters and policymakers through much of 2025 - when will India and the U.S. sign a trade deal? In the first week of 2026 itself, Trump has said the U.S. could raise tariffs on India over the Asian nation's imports of Russian oil.

India falling out of favour with the U.S. was the biggest surprise of 2025. Despite months of negotiations and the Asian nation offering to bring down trade tariffs significantly, a deal has eluded the Narendra Modi government.

Oil purchases from Russia and Modi's apparent unwillingness to accept Trump's role in halting a brief India-Pakistan war have been speculated by commentators as reasons behind the stalled deal.

Russian oil imports have slowed, albeit modestly, tensions between the nuclear-armed neighbours have receded and calls between Modi and Trump have continued.

Still, no deal.

The disappointment has been most evident in the Indian currency markets, with the rupee suffering its worst annual drop in three years despite a weakening dollar and significant intervention from the Reserve Bank of India (RBI).

The damage, contrary to expectations, has not come from declining exports, which have been resilient so far. Instead, it has been a sharp drop in foreign flows, majorly from equity investors cautious about frosty India-U.S. relations.

The market's patience is running thin, Asia macro strategist Vivek Rajpal at investment advisory firm JB Drax Honore had told Reuters, citing the lack of a deal as a key reason for foreign investors staying away from India despite a cheap currency and more reasonable equity valuations.

WORLD'S FOURTH-LARGEST ECONOMY

Besides geopolitical unknowns, fundamental surprises too hit the Indian economy and its markets.

India enters 2026 as the world's fourth-largest economy overtaking Japan, the government said in a year-end statement, although formal confirmation of the milestone will come from the IMF.

The ranking was a matter of time but the strength of the Indian economy in 2025 surpassed expectations, including the central bank's which raised its growth forecast by 80 basis points over the course of the year to 7.3% for the 12 months ending March 31.

Some private forecasters peg growth even higher.

Equally surprising has been the fact that high growth has been accompanied by record-low inflation - a 'Goldilocks' economy as RBI governor Sanjay Malhotra called it.

Will the not-too-hot, not-too-cold economic conditions hold in 2026?

BofA Securities forecasts GDP growth at 7.6% this financial year, slowing to 6.8% in the next because of a lagged effect of trade measures. Nomura sees the inflation rate rising from the unusually low 2% this year to 4% in 2026-27 - matching the central bank's target.

That mean reversion for both growth and inflation will be beneficial, economists say. It will help push up low nominal growth seen in 2025, which hurt tax collections and corporate revenues.

WORST EQUITY UNDER-PERFORMANCE IN DECADES

In contrast to the robust economy, equity markets were surprisingly weak.

Strong economic growth was not enough to entice global investors who were chasing an AI rally. India closed 2025 with its worst annual relative performance versus the MSCI Emerging Markets Index since 1994, with foreign investors selling a record amount of Indian shares.

What are the trends for flows in 2026?

Morgan Stanley lists several reasons, ranging from a trade deal to reforms, that could set Indian equities up for a rally this year.

"In a likely action-packed quarter, we expect earnings to beat, the RBI to keep its foot on deregulation, more reforms from the government, and a potential trade deal with the U.S.," equity strategist Ridham Desai wrote in a January 1 note.

Franklin Templeton, while citing several factors supportive of a rebound, also flagged two risks spilling over from 2025 - a weakening rupee and continuing large share sales from existing investors which overwhelmed demand for equities.

MARKET MATTERS

Precious metals had a historic year in 2025, with gold, a favorite among Indian buyers, rising nearly 65%.

The soaring prices are making customers wary about buying jewellery but they are still piling into the yellow metal for investment via small coins and bars.

Analysts expect this trend to persist in 2026, according to a Reuters report by Rajendra Jadhav and Polina Devitt.

Read more here.

THIS WEEK'S MUST-READ

India's dominance of the global rice trade is coming at a cost - depleting groundwater in a country where water shortages are hurting consumers and industries.

India overtook China as the world's largest producer of rice in 2025 and exports have doubled over the past decade but farmers are having to drill ever-deeper borewells to access water.

Read this Insight by Mayank Bhardwaj and Bhawika Chhabra, the latest in a series on India's water crisis, here.

Alongside agriculture, industries from beverages to power are hurting due to India's widening water crisis.

(Reporting by Ira Dugal; Editing by Muralikumar Anantharaman)

((Ira.Dugal@thomsonreuters.com; +91-9833024892;))