19 Aug 2025
We’ve seen it all in the last 72 hours. An S&P upgrade after 18 long years of waiting. A promise of Goods and Services Tax (GST) rate cuts by Diwali, bringing cheer to consumers. And important geopolitical meetings between Presidents Trump and Putin, and then Trump and President Zelenskiy, which could have implications for the 25% secondary tariff levied on India for buying Russian oil.
Where does this leave Indian markets and the economy? While analysing them all, we realise that, in terms of the impact, the three developments are closely interlinked.
After revising India’s outlook to positive last year, S&P Global Ratings upgraded India’s sovereign credit rating to BBB from BBB-on 14 August. This move may not just boost sentiment, but also help lower the risk premia and borrowing costs in the economy.
The long wait ended, thanks to a much-improved economic outlook according to S&P. It highlighted India’s fiscal discipline since the pandemic, with the combined fiscal deficit falling to 7.3% of GDP in FY26 from 13.4% at the pandemic’s peak. The quality ofexpenditure has also improved. Meanwhile, inflation has been contained despite exogenous shocks, and the current account deficit remains low despite the rise in public capex.
However, that was in the past. Looking ahead, it is clear that S&P has based its big move on two key projections. That GDP growth will average 6.8% over the next three years. In addition, the consolidated fiscal deficit will fall further from 7.3% now to 6.6% by FY29, marking a 0.7ppt consolidation in three years. These, together, will help lower public debt (from above to below 80% of GDP).
While there is no immediate threat of the ratings upgrade being reversed if the projections do not materialise, for the sustainability of current ratings and future upgrades, it is worth asking what it will take for S&P’s projections to be correct.
Here we pass on the baton to the GST tax rate cuts, for that could affect S&Ps desire for 0.7ppt fiscal consolidation over three years.
On 15 August, Prime Minister Modi announced an overhaul of the GST tax regime. Slashing rates across a range of products, by moving the majority of the items in the 12% and 28% slabs to the 5% and 18% slabs, respectively. In addition, collapsing a system of four key GST rates (5%, 12%, 18%, and 28%) into two main rates (5% and 18%) alongside a special rate (of 40% for about seven sin goods and luxury vehicles). The compensation cess is also likely to be subsumed by the 40% special rate.
This promises to bring two benefits. Immediate tax cuts could spur demand across products –food, beverages, consumer durables, autos, hotels, cement, building materials, etc. And over time, efficiency gains of moving to a simpler and more predictable tax regime with fewer rates, could raise India’s potential GDP growth over time (though some would say that there is more that can be done on GST reforms, for instance, bringing in petroleum and electricity in the GST fold).
So far so good.
However, things begin to get complicated when we ask who will foot the bill on tax cuts. Best to pause here to clarify that many of the details on the new GST rates are not yet known and we are developing a possible scenario based on the information we have.
We estimate that as some products are moved to lower tax buckets (from the 12% to the 5% bin, and from the 28% to the 18% bin, though a minority may be pushed up from the 12% to 18% or from 28% to 40% too), the cost to the exchequer will be around USD16bn (INR1430bn, 0.4% of GDP). In the GST spirit, this could be equally split between the central and state governments.
The centre has other revenue sources to count on, but states do not have as many options. They may not agree to the revenue hit. Their complaint could be that they already follow the FRBM Act whereby they must keep the fiscal deficit below 3% of GDP. Now following the GST rules and cutting tax rates could be a difficult task, unless they cut other important expenditure like capex.
If the central government then comes up with a compensation plan to handhold states for a few years, the funds would have to be made available. If these funds are generated by a GST tax hike in say, some luxury goods or suchlike, that would go against the efficiency principles of having fewer GST rates.
This is important because the GDP growth boost from efficiency gains could then be compromised. And the expectation of high tax revenue growth on the back of stronger GDP growth prospects may not materialise.
One can point out that losing some efficiency and growth gains temporarily may be a price worth paying for a long-term reform. But that, we think, will be easier to digest if the overall outlook for growth over the short term is buoyant. Is that the case?
The 25% + 25% tariff rates imposed by the US authorities on India’s exports (starting 27 August as of now), have dimmed some of the growth prospects.
To recap, c20% of India’s overall exports go to the US, valued at 2.2% of GDP. Thankfully a-third of these exports remain exempt from these tariffs. Yet, we calculate that a 25% tariff could lower growth directly by 0.3ppt over a year, and with a 50% tariff, the growth drag could rise to 0.7ppt.
The second round and indirect impact of the elevated tariffs could be meaningful, if not more hurtful. The main non-exempted items that India sells to the US like jewellery, textiles, and food items, are associated with labour-intensive small firms, and disruption there could impact domestic consumption demand. FDI inflows and corporate capex (at about 12% of GDP) could take a hit if India’s exporting potential comes into question.
So will these tariff rates stick?
While it is hard to forecast here, recent developments are worth tracking. On the oil penalty, much depends on the ongoing peace talks, where, as per a Bloomberg report (18 August), following meetings with the two heads of state, President Trump has calledPresident Putin, urging him to plan a summit with President Zelenskiy within the next two weeks.
On the reciprocal tariff, much depends on the ongoing trade talks between India and the US. On 18 August, the Indian government removed import tariffs on cotton imports, a step that could create fresh room for continued negotiations.
Putting it all together, if tariffs are eventually lowered, the GDP growth drag could soften too. If the growth outlook improves, it may be easier to digest the short-term disruptions associated with funding the GST rate cuts. If fiscal discipline is maintained despite GST rate cuts, the projections on which India achieved a ratings upgrade, will be upheld.
We may have to wait a bit longer to ascertain whether clouds are lifting, or just shifting. In the meantime, it would serve India well to have a growth plan, ranging from fiscal support (incentives for exporters), monetary easing (we believe there is some more room available for rate cuts), to structural reforms.
On reforms, now is the time to press ahead with trade negotiations (slashing import tariffs on intermediary inputs, fast-tracking the India-EU trade deal, and being open to FDI especially from China), as well as domestic reforms (more ease-of-doing business deregulation across states, implementing the four labour codes, and stepping up disinvestment).
While we await details on taxes and tariffs, it will benefit the economy immensely if this is a start of a string of growth-enhancing reforms.
Additional disclosures
1. This report is dated as at 19 August 2025.
2. All market data included in this report are dated as at close 18 August 2025, unless a different date and/or a specific time of day is indicated in the report.
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