The World India Must Budget For
President of the United States Donald Trump greets General Secretary of the Chinese Communist Party Xi Jinping before a bilateral meeting at the Gimhae International Airport terminal in Busan, South Korea, in 2025. Trump is scheduled to travel to China in April (Official White House Photo by Daniel Torok/Public Domain)
As India looks ahead to its next Union Budget on February 1, global factors are shaping the broader context which its economy must navigate in the coming year. Developments in the world’s two largest economies—the United States and China—will shape that context.
The US economy ended 2025 on a strong note, registering a robust 4.3 percent growth in the third quarter, driven largely by consumer spending. Yet the underlying structure reveals significant imbalances. Investment growth is almost entirely concentrated in the expansion of AI capacity, a momentum unlikely to be sustained. Corporate hiring has virtually stalled, AI-related stocks display unsustainably high price-to-earnings multiples, and it remains unclear what final consumption demand for AI-enabled output will be.
At the same time, expansion of AI capacity is highly energy-intensive and this will be an issue, especially as capacity building shifts overseas to some developing countries.
Consumption growth is heavily skewed toward upper-income households and is likely to taper off. Broader trends will depend on how President Donald Trump’s proposed tax cuts are financed. If tariff revenues are used, this may work briefly—at least in FY 2025–26. In May 2025 tariff revenues were four times higher than in May 2024 and 25 percent higher than in April 2025. This was despite little change in import prices.
However, the sharp rise in average tariffs—from about 2 percent to nearly 10 percent—will feed into domestic inflation, choke consumption demand, and eventually erode tariff revenues.
Tax cuts will also add to government debt, pushing it onto an unsustainable path and raising interest rates. The combined effect will be a contraction in both consumption and investment demand. A similar sequence followed the imposition of “reciprocal tariffs” earlier, raising doubts over whether the late-2025 spurt in US growth can be sustained.
China’s outlook is even more troubling for global demand. Growth has been on a long-term decline—from 8–10 percent in the decades after 1980, to around 7 percent in 2023–24, about 5 percent in 2024–25, and now trending lower. The real estate crisis continues to depress demand, while ageing demographics further constrain consumption.
Even China’s recent export surge offers limited reassurance. Much of it reflects diversion of exports away from the US toward developing countries, many of which are now responding with higher tariff and non-tariff barriers.
Another portion is driven by tariff arbitrage, with Chinese goods reaching the US indirectly via partners such as Mexico and Vietnam. This channel is unlikely to last. The US is expected to block such routes, and Mexico has already imposed tariffs of up to 35 percent on countries with which it doesn’t have Free Trade Agreements (FTA) and 50 percent on automobiles and auto parts.
Potential growth areas
From India’s perspective, global trade prospects in 2026 are therefore limited, except for some resilience in services trade, largely linked to the US economy. The recent spurt in commodity trade was driven by pre-emptive purchases ahead of the Trump tariff regime that took effect after August last year. What, then, can be expected in 2026?
Trade diversion away from the US offers some scope. Other partners such as the EU and UK could play a role, particularly through trade agreements that may revive textile and leather exports hit by the 50 percent US tariffs. During his recent visit to India, German Chancellor Friedrich Merz floated the possibility of concluding an India-EU Free Trade Agreement by February.
Petroleum products and pharmaceuticals are likely to continue selling even in the US market. However, the strongest momentum is likely to lie in services trade, where negotiations are now being seriously pursued in most FTA discussions.
The best outcome for India, nevertheless, would be the removal of prohibitive US tariffs. If that happens, it would be business as usual: India would remain the preferred “new China” destination, attracting foreign direct investment from the US and Europe.
India’s recent high growth rates and favourable demographic profile remain its strongest long-term asset while technology infusion via foreign direct investment remains the best bet.
The challenge, as ever, lies in translating this potential into sustained income growth. Unfavourable tariff treatment by the US would deter most investors from other countries of the 38-member Organisation for Economic Cooperation and Development (OECD) bloc.
The real issue in global trade lies in rejuvenating global demand, and here the main culprit is China. With foreign reserves of over $US 3.2 trillion, it has created excess global savings. To boost global demand, China must now turn into a global buyer from being a global saver. But for President Xi Jinping, political stability is related to increasing exporter incomes—and that is the group most likely to resist change to the status quo.
Will 2026 see a reversal? Can Xi make the hard political sell?
China, like America, remains a bull in the china shop of the global economy.
