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Evolving trade strategy

India’s external trade continues to evolve in midst of geopolitical fissures. Navigating this shift has not only become increasingly complex, but also consequential. We expect the economy to balance its growth ambitions against the backdrop of intensifying geopolitical constraints.

The evolving strategy has been a function of broadening trade linkages, fast tracking trade agreements, and exploring new markets.

Firstly, we gauge the early impact of trade with the US in the face of higher tariffs. The US had imposed a 25% base rate and 25% penalty on goods exports from India last year, which remains in force. Trade negotiations are ongoing, though the timeline for a resolution remains unclear.

India’s goods exports averaged ~6% yoy in 2H CY25, improving from a near 2% drop in the comparable period year ago. The regional breakdown shows that exports retained their foothold despite slower exports to the US (see chart). Since elevated tariffs kicked in, exports to the US have contracted by -0.2% yoy between Sep-Dec25. Despite this, headline exports to rest of the world (ex US) rose 5% yoy in the same period. One of the more notable uptrends were the sharp 58% yoy increase in exports to China between Sep and Dec25, consisting of organic chemicals, petroleum products, iron ore, and electronics. Exports to Hong Kong also averaged a strong 30% yoy. We expect this outperformance to move the needle for overall trade in the medium-term, as the current share of exports to China amounted to a modest ~3.2% of total exports in FY25. The bilateral trade deficit at a fresh annual high at -$107bn (in CY2025).

To that effect, the traditional mix of trading partners is undergoing a change. While maintaining trade ties with the US (~20% share in FY25 exports), EU (17%), Middle East (13%) and Japan (1.4%), the mix of trading partners is likely to widen to strengthen ties with the others, including ASEAN region (currently at 9%), China (3%), EFTA (0.5%), Latin America (3.5%) and Africa etc.

Secondly, bilateral trade agreements have been fast-tracked after years of prolonged discussions. A case in point is the just concluded deal with the EU, which was India’s 22nd FTA agreement (see details in the next section) in the past decade, according to the government. The deal with the European Free Trade Area (EFTA) came into effect in 4Q25, while fresh agreements were concluded with Oman, the UK and New Zealand (see table). The newer deals emphasize not just on tariff reductions, but also services, investment commitments, and digital trade. Other stand-out features of recent agreements have been the speed of negotiations, a push to seek market access to boost FDI, integration into western value-added supply chains, and push to secure more markets for services, including avenues better labour mobility.

Lastly, pushing through a larger footprint in service exports, including smoothening the process of manpower mobility (India: Re-orientation amid global restrictions), which will be a key counterweight for any signs of weakness in goods imports.

We elaborated on some of these nuances in India 2026 Outlook: Reform and resilience.

India-EU finalise a trade agreement

In continuation with India’s move to fast-track bilateral trade agreements to counteract a challenging global trade outlook, India and EU finalised a landmark trade deal on Tuesday. After two decades of negotiations, this deal marks one of the largest signed in recent years. The two partners account for close to a quarter of the world GDP, and a third of trade.

India’s access to the broader European market is expected to improve, factoring in last year’s deal with the UK and European Free Trade Area (EFTA). Notably strengthening ties with India will also be of strategic importance to the EU as well it seeks to diversify its strategic interests away from the US and seeks deeper alliances in South and Southeast Asia.

India-EU trade linkages have strengthened over the past four-five years. In FY25, the European Union accounted for about 17% of India’s exports, while making up for 8% of imports, which stood at a cumulative ~3.5% of nominal GDP. Nominal goods exports to EU were relatively steady around $75.5bn between 2023 and 2025, along with imports at around $61bn. India enjoyed a trade surplus of $15bn last year.

Key commodities that comprise exports include ‘new economy’ sectors like electronics, machinery, chemicals etc., besides the traditional labour-intensive sectors. India has primarily imported aerospace inputs, electronics and machinery from the EU, making up less than 1% of EU’s total exports. Indian firms are also likely to step up investments in Europe. India-EU trade in services reached $83.1bn in 2024. The EU’s FDI stock in India reached $166bn in CY2023 vs $97.9bn in CY2019, with about 6,000 European companies currently operating in India.

Fine print of the just concluded deal includes:

• Beyond formalisation of the agreement, the deal will be effective in January 2027, after ratification by all the EU member states. There are 21 chapters under the deal.
• The FTA has been referred to as “living agreement” to mean that there are in-built mechanisms for reviews and consultations to tackle changes.
• The EU has agreed to lower tariffs on ~99.5% of the value of goods imported from India, which in turn covers ~96.8% of its tariff lines.
• This implies that three-fourth of tariff lines covering 90.7% of India’s exports will have immediate duty elimination for important labour-intensive sectors such as textiles, leather and footwear, tea, coffee, spices, sports goods, toys, gems and jewellery and certain marine products, amongst others (details).
• On India’s end, tariffs will be liberalised on ~97% of goods imported from the EU, covering 92.1% of the lines. India will lower duties to 0% on about a third of imports immediately and will widen the coverage to 93% over the coming decade.
• On services, India has opened about 102 sub-sectors and EU has over 144 (which includes IT/ITeS, Professional Services, Other Business Services and Education Services); there are also few commitments on study/ post study mobility for the workforce.
• There are sector-specific exemptions. Reduction in tariffs will be phased for sensitive areas like automobiles, agriculture and steel. Dairy, cereals, poultry and sugar, have been exempted for the time being. Further examples include Indian duties on premium wines which are set to fall from 150% to 75% in year one and thereafter gradually towards 20-30%.

There are special provisions for the sensitive auto sector as authorities weigh the impact of strong imports on the domestic manufacturing sector. A quota-based reduction will be undertaken – for the first year, import duties will be lowered from 110% to 30-35%, which will be then lowered to 10% over time. There will be an exclusion for cars prices below INR2.5mn (mass market) to safeguard the domestic industry, while premium segments will be more open. Add to this, access to EV markets will not be immediate and will open after five years.

• EU’s Carbon Border Adjustment Mechanism that kicked in on 1-Jan will remain in place.

Impact of the deal

The deal will kick in by early 2027, after the rest of the ratification process is complete. We note that the EU’s recent notification on the cessation of the GSP benefits had materially pushed up tariffs on India’s exports, though was expected to have impacted only 2.7% of India's exports to the EU.

A conservative CAGR of 5% between FY2025 and 2030 can potentially lift India’s exports to the EU by a third to $97bn or 10% CAGR could lift the nominal exports by three-fifths to $122bn in the same period, also widening the trade surplus. In effect this could see the EU stay as a key market for India’s exports (take share to above 20%).

Sectoral boost could be broad-based. The effective tariffs on India’s exports to the EU will be near zero, namely chemicals (current 13%), apparel/ textiles (12%), base metals (10%) etc. For a start, pharma, textiles, chemicals, and electronics stand to gain from the deal. Digging deeper, for instance, for the readymade garments industry (GSP withdrawal had pushed up the prevailing tariff rate), which was at a disadvantageous position before the deal, as peers like Vietnam, Bangladesh, Pakistan etc enjoyed duty free access to the EU market, while India’s faced higher duty. With India’s current readymade garment exports to the EU at circa $4.0-5.0bn, making up a modest market share, there is scope for strong growth in this sector when the new rates kick in by January 2027. For pharma, provided non-tariff barriers and regulatory restrictions are addressed, India’s exports could expand strongly into the region.

In conclusion

Strength in the domestic economy and potentially higher exports pose upside risks to our FY27 growth forecast which is currently at 6.5%. We await the release of the revised/ rebased series due late February before reflecting changes.

While the announcement is not market-moving, it will benefit India’s evolving trade dynamic to diversify its trading partners, while also benefiting the EU to better balance its adverse trade balance with India.

A weaker rupee reflects volatility in capital flows rather than the current account dynamics. Domestically, the downward pressure on the rupee comes at a time of apparent strength in economic growth, with the 1Q-2QFY average at 8% yoy and our forecast at above 7.5% for FY26. Inflation has also been at moderate levels. How does one square that circle? Dollar demand has broadly risen. While the current account shortfall has narrowed on the back of services, monthly goods imports has risen materially in 9M FY26, partly due to precious metals. A weak currency does cushion rupee earnings for exporters affected by higher tariffs (INR REER continues to slip) but has caused distortions elsewhere. The annual CAD will still look manageable at close to -1.0-1.2% of GDP, but capital flows have been the bigger bother. After net outflows in 2025, equity markets have witnessed -$3.7bn outflows this CY, while bonds attracted tepid interest. Net FDI is faring better than last year but is still at a gap vs gross FDI due to repatriation pressures. The fiscal impulse will be more apparent at the upcoming Budget (see our Budget preview), as cumulative general government borrowings are expected to rise in FY27.

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