Inflation remains the major risk going forward for the financial year 2026 due to the higher cost of raw materials, a DAM Capital report added.
The report added that inflation is a foremost concern for FY26, with a projected decline to 4.5 per cent from the current level.
The major reason behind the persistent inflation is domestic pressure. The pass-through effect of rising raw material costs, particularly in agriculture, food, and metals, is expected to contribute to persistent inflation. As demand increases, businesses are likely to raise prices of raw materials, impacting consumers.
External factors are also a concern, particularly the ongoing tariff war and the depreciation of the Chinese Yuan.
Given China’s vulnerability, the report predicts that the Yuan will likely see a steeper devaluation compared to the INR, putting additional pressure on India’s inflation levels.
Furthermore, geopolitical tensions and policies, such as former U.S. President Donald Trump’s “Make America Great Again” agenda, could spur demand for the US dollar, further complicating India’s inflation outlook.
Despite these risks, experts highlight that China’s deflationary pressures and the resulting Yuan depreciation could provide some relief by making Chinese exports more competitive and potentially easing inflationary pressures in India.
The Rupee performance against the US dollar is another critical area to watch. The Indian Rupee is expected to depreciate to an average of 86.50-87.0 against the dollar by FY26.
This reflects a consistent weakening trend, from a rate of 84 to 85 in just two months, and further depreciation over the past year.
The US Federal Reserve’s higher interest rates are attracting capital flows into the dollar, leading to a widening gap between Indian and US interest rates, as per the report.
Ongoing geopolitical tensions, the slowdown in China’s economy, and a global growth disparity favouring the US could result in a stronger dollar, further pressuring the Rupee.
The growing trade deficit, especially with rising imports and a larger goods trade deficit, is exacerbating the Current Account Deficit (CAD), expected to reach 1.4 per cent of GDP in FY26.
The report added that the Reserve Bank of India (RBI) is likely to allow for this depreciation, although intervention through forex reserves and policy adjustments could be used to prevent an excessive fall. Experts suggest that the fair value of the rupee, based on the Real Effective Exchange Rate (REER) index, is around 90, signalling that the INR is currently overvalued by more than 8 per cent.
Under the leadership of the new RBI governor, monetary policy is expected to balance growth with inflationary pressures and the need to defend the Rupee, the report added.
(With inputs from ANI)
