2025 delivered rate easing; 2026 will be about transmission. With inflation expected to remain within the RBI's comfort band, policy should stay growth supportive but shift emphasis from fresh rate cuts to ensuring the 2025 easing fully transmits to the economy and fixed income markets. Proactive liquidity provision will be central to this transmission. Based on an estimated ~US$80bn forward USD short position and rising currency leakage, we expect the RBI to infuse roughly ₹5 trillion of additional durable liquidity via OMOs by the end of next fiscal, on top of the currently announced measures. This should keep the supply demand balance favorable for rates.

Supply dynamics improved after mid 2025 stresses. Despite a friendly macro backdrop through 2025, yields backed up from mid year as excessive duration supply met patchy demand, especially from banks. Looking ahead, overall paper supply appears moderate once OMO absorption is considered. Both the Centre and States seem attentive to market appetite for duration, have already begun trimming longer tenor issuance, and we expect further moderation in FY27. A rising term premium has increased borrowing costs, which is particularly challenging under the new fiscal framework targeting the debt to GDP ratio. The Centre retains buffers-low T bill outstanding and stronger small savings collections-supporting moderate supply in FY27. On the demand side, we anticipate normalization in banking sector appetite for SLR securities in FY27 as the credit deposit ratio, currently at record highs, stabilizes. We see the India 10 year gravitating toward ~6.25% and averaging in a 6.25–6.50% range.

Growth outlook is constructive, but headline Real growth maybe lower. We are positive on FY27 growth, projecting nominal GDP to rise to ~9.75%. Key drivers include the pass through of prior monetary and fiscal stimulus, a likely reduction in tariffs (supporting exports), and robust rural demand anchored by healthy agricultural output and continued fiscal support. Corporate balance sheets are strong, capacity utilization is elevated, and conditions are broadly ripe for a capex cycle-though global uncertainty is the principal risk. Despite this constructive backdrop, we forecast real GDP at ~6.75% as base effects and a low GDP deflator in the prior year mechanically damp headline real growth. One source of uncertainty is the new GDP series slated to be introduced from February 2026 onward.

Fiscal consolidation should continue. We expect the FY27 fiscal deficit at ~4.2% of GDP. No major taxation changes are anticipated; rising nominal GDP and deeper formalization following earlier tax rate reductions should underpin tax collections. Revenue expenditure is likely contained, with some increase in capital outlays for defence. We expect another healthy RBI dividend and improved non tax revenues supported by lower crude prices.

Inflation normalizing yet comfortably within target. After very low prints in 2025, averaging 2.2%, inflation should normalize but remain well within the RBI's target band, keeping monetary policy easy and growth supportive. We expect crude to stay comfortable, household inflation expectations anchored, and agricultural output solid across the 2025 Kharif and 2026 Rabi seasons (recognizing the lead lag dynamics between output and food prices). China's exported disinflation should persist into 2026. Upside risks mainly stem from adverse weather-there is some probability of El Niño in H2.

External position: moderate BoP surplus; INR stabilization ahead. Recent INR pressure largely reflected BoP weakness, driven more by the capital account than current account effects from US tariffs. We expect capital inflows to improve in 2026-both equity and fixed income FII, as well as a pickup in FDI. FII equity allocations to India are currently low; we see scope for re allocation amid higher nominal growth, which correlates better with corporate returns. We expect USD/INR to stabilize and moderately appreciate as US tariffs are reduced, with a 2026 average near 89. The rupee's real exchange rate appears significantly undervalued, arguing for some appreciation-timing contingent on tariff normalization. Notably, the CNY's real exchange rate has weakened more than INR recently; maintaining competitive parity with China may feature in the policy toolkit given the growing bilateral trade deficit and the push to boost manufacturing. We also anticipate rebuilding of FX reserves once appreciation pressures emerge.

Risks are chiefly global. Key watch points include geopolitics and oil-while our base case keeps crude benign, Iran related flare ups pose upside price risk. Strategically, India's challenge is to navigate US relations while preserving autonomy and balanced ties elsewhere. Easing US tariffs remains pivotal for exports, capital flows, and currency stability. Domestically, an El Niño in the second half would be a late year risk.

Investment stance: attractive real rates and improving transmission. Real rates are elevated; combined with the supportive macro and expected transmission of past easing, Indian fixed income offers compelling opportunities. As always, allocations should match investor horizons:
• 1–3 months: Aditya Birla Sun Life Savings Fund; Aditya Birla Sun Life Money Manager Fund.
• 3 months+: Aditya Birla Sun Life CRISIL IBX Financial Services 3–6 Debt Index Fund; Aditya Birla Sun Life Low Duration Fund; Aditya Birla Sun Life Floating Rate Fund.
• 6 months+: Aditya Birla Sun Life Banking & PSU Debt Fund; Aditya Birla Sun Life Corporate Bond Fund; Aditya Birla Sun Life Short Term Fund.
• Tactical (1 year+): Aditya Birla Sun Life Income Fund or Aditya Birla Sun Life Long Duration Fund.

In sum, 2026 should be the year that policy easing truly permeates through markets and the economy. With prudent supply management, steady fiscal consolidation, benign inflation, and improving capital flows, we see scope for lower long-term yields, stable currency, and attractive carry supporting fixed income allocations for the investors.

Source: ABSLAMC Research

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