Tax Cuts To Help GDP Grow Past 6.5% In FY26, Inflation To Decline: Moody's

Tax cuts for the middle class and increased government capital expenditure will help India log a gross domestic product growth of more than 6.5% in financial year 2026, Moody's Ratings said in a report issued on Wednesday.

The projection assumes significance, as the pace of India's GDP growth has been modest over the past two quarters. The growth was of 5.6% in the July-September period and 6.2% in the October-December quarter. For the entire fiscal ending March 31, 2024, the projected rate of growth is 6.3%, Moody's said.

In the Union Budget presented last month, the government raised the income tax exemption limit to Rs 12 lakh, and tweaked the tax slabs to benefit those earning more than this threshold. This tax sop, which will cost the exchequer an estimated Rs 1 lakh crore, will boost consumption, as per Moody's.

India's growth prospects would also be supported through monetary easing, the ratings agency said. The Reserve Bank of India, for the first time in five years, reduced the benchmark lending rates in February with a 25 basis points cut. "But we expect further rate cuts to be modest, as the central bank takes a cautious stance amid global uncertainty around US trade policies," Moody's noted.

Inflation is expected to cool further, approaching closer to the RBI's medium-term target of 4%, according to the report. "We expect India's average inflation rate to decline to 4.5% in fiscal 2025-26", as compared to the estimated 4.8% in the fiscal 2024-25.

The profitability of Indian lenders will remain at "adequate levels", despite a marginal decline in net interest margins, as banks will reflect policy rate cuts in loan rates before repricing deposits, as per Moody's.

However, banks' non-interest income will be strong on the back of "large business volumes, led by wealth and insurance services, and opportunistic bond gains", it said.

The loan-loss provisions will remain modest despite slight "increases from cyclically very low levels", the ratings agency said, adding that it expects the systemwide return on assets to be 1.25-1.4% in fiscal 2026.

The banking sector's profitability has improved substantially in the past few years mainly because of decreases in loan-loss provisions in line with improvements in asset quality. The systemwide ROA increased to 1.4% in first half of fiscal 2024-25 from 0.7% in fiscal 2020-21, it pointed out.

Banks' capitalisation will "remain strong" as their internal capital generation keeps pace with capital consumption, with their dividend policies continuing to be prudent, according to Moody's. "We expect systemwide assets to grow 11-13% and the banking sector to generate a return on equity of 12-14%, supporting stable capital," it added.

On asset quality, Moody's expects banks' non-performing loans ratio to "increase moderately after substantial improvements in recent years". The systemwide NPL ratio dropped to 2.6% as of the end of September 2024 from 7.3% at the end of March 2021, it said, adding "we expect the systemwide NPL ratio to be 2-3% in next 12-18 months."