Why India still matters despite tariffs and tensions

Key points:

• India has long delivered strong returns and diversification, but investors are questioning exposure now as the U.S. threatens tariffs of up to 50% on key exports.
• The fundamentals remain intact — supported by demographics, digitization, and GST reforms — and India is still the world’s fastest-growing major economy.
• The opportunity comes with risks and higher volatility, from tariffs and geopolitics to currency fragility and rich valuations.

India remains one of the world’s most compelling growth markets — a $4 trillion economy with demographics, digitization, and capital-market depth that global investors crave for diversification. But the halo comes with sharper edges.

The U.S. tariff escalation has clouded near-term earnings for export clusters, geopolitics are fluid, and valuations, while off their highs after a correction, remain expensive versus emerging-market peers.

The result: investors still want access, but positioning requires more nuance and attention to risks.

Tariffs and the offsets

The United States’ decision to double tariffs on select Indian goods to as high as 50% has rattled parts of India’s export engine, such as textiles, gems and jewellery, footwear, chemicals, and even solar modules. For exporters in these industries, order books may shrink and margin pressures will build until new markets are tapped.

But the pain is being cushioned by two offsets:

• A weaker rupee has made Indian goods more competitive globally, partially blunting the impact of higher tariffs.
• More importantly, the government’s sweeping GST reform is set to cut taxes on hundreds of consumer products and simplify the system to two main slabs (5% and 18%), supporting household demand.

Together, these measures inject resilience into GDP growth by leaning on domestic demand to counter external drag.

Net-net, while goods exports will take a hit, the domestic-demand engine, which already makes up nearly two-thirds of GDP, will keep India anchored in the 6–6.5% growth range in 2025.

For investors, the key question is not whether tariffs hurt — they sure do — but when and where they might be normalized. Trade policy is often cyclical, tied to election calendars and bilateral negotiations.

A thaw in U.S.–India relations, or a shift in U.S. tariff priorities, could restore export momentum faster than expected, creating upside risk for Indian exporters. Until then, portfolios should be tilted toward areas less vulnerable to the tariff regime.

Geopolitics: Aligning with China and Russia

India’s stronger engagement with China and Russia underscores the pragmatism driving its foreign policy. By deepening ties through BRICS and bilateral agreements, India is broadening access to energy supplies, diversifying trade partners, and securing strategic raw materials. This approach may insulate the economy against U.S. tariff shocks in the medium term.

The trade-off, however, is a more complex relationship with the West. Investors must account for the possibility of secondary sanctions, financing restrictions, or slower capital flows if geopolitical lines harden.

For investors, this dual track underscores the importance of diversification across sectors and asset classes when seeking India exposure.

Structural strengths

India’s investment case rests on a blend of deep structural drivers and near-term supports that together help justify its market premium.

• Demographics: With one of the youngest populations in the world, India benefits from a demographic dividend that fuels household consumption, labor supply, and productivity growth. Rising incomes and urbanization will continue to expand demand for housing, credit, and consumer goods.
• Digitization: Public digital infrastructure — from UPI payments to Aadhaar and ONDC — has transformed commerce and finance by cutting transaction costs and improving access. This wave of digital adoption enhances efficiency and broadens participation in the economy.
• Capex and infrastructure momentum: Large-scale government investment, supplemented by private capex through Production-Linked Incentive (PLI) schemes, is creating industrial corridors, improving logistics, and boosting manufacturing capacity. These projects underpin longer-term diversification away from pure consumption.
• Financial system resilience: Indian banks are better capitalized and cleaner than in past cycles, with non-performing loans at multi-year lows. Combined with rising domestic savings, this provides a stable funding base for markets, reducing vulnerability to swings in foreign flows.
• Services engine: IT and IT-enabled services remain globally competitive, delivering steady dollar earnings that help offset volatility in goods exports. Demand for outsourcing and digital solutions keeps this sector resilient.
• Earnings momentum: Analysts are beginning to upgrade corporate earnings forecasts, reflecting stronger-than-expected consumption after GST cuts, resilient credit growth, and the cushioning effect of a weaker rupee on exporters.
• Policy flexibility: With inflation moderating, the Reserve Bank of India has room to cut rates later in 2025, which would ease borrowing costs and support investment. This policy cushion provides a tactical boost to growth at a time when global liquidity is tightening.
• Liquidity and reforms: Persistent inflows from domestic households and institutions provide a reliable anchor for the equity market, while ongoing reforms — from GST simplification to digitization — continue to raise efficiency and reinforce long-term growth potential.

Taken together, these forces give India both durability and momentum. The structural story makes it a long-duration growth asset, while the tactical tailwinds provide near-term justification for its premium valuation relative to peers.

Risks to the outlook

While India’s growth story is attractive, several risks could weigh on the trajectory of earnings and valuations:

• Tariff uncertainty: The doubling of U.S. tariffs on select Indian goods highlights the fragility of global trade ties. Export-oriented sectors such as textiles, gems, chemicals, and solar modules face margin pressure, and normalization timelines remain uncertain. Prolonged frictions could hurt corporate earnings and widen the current account deficit.
• Currency fragility: The rupee remains one of the more volatile Asian currencies due to India’s structural current account deficit and reliance on imported energy. Global risk-off episodes, higher oil prices, or capital outflows could push the INR weaker, eroding unhedged investor returns.
• Twin deficits and fiscal risks: India’s wide fiscal deficit and external imbalance increase its vulnerability to sudden shifts in investor sentiment. Rising government borrowing could crowd out private investment or keep bond yields elevated, weighing on valuations.
• Energy and climate shocks: Heavy dependence on imported crude and weather-sensitive agriculture exposes the economy to inflation volatility. Food or fuel shocks can quickly squeeze consumer spending and complicate the RBI’s policy path.
• Execution on reforms and jobs: Delivering large-scale manufacturing employment and ensuring smooth implementation of infrastructure projects remain execution challenges. Falling short here could undermine long-term growth.
• Limited AI exposure: Unlike the U.S. or China, India’s listed equity universe has relatively low direct exposure to AI beneficiaries. While IT services companies provide indirect exposure through global outsourcing, the lack of large-scale domestic AI hardware or platform leaders limits India’s ability to capture this secular growth driver. This could leave Indian equities lagging in global technology re-ratings.
• Valuation sensitivity: Even after a correction, Indian equities still trade at a significant premium to emerging market peers and above their 5-year average multiples. MSCI India trades at about 21–22 times forward earnings, which is a heft 60–65% premium to MSCI Emerging Markets index and just above the 5-year average of 21.6x. Without sustained earnings upgrades, there is a risk of valuation compression if investor sentiment shifts.

The investor take

At the portfolio level, broad-based India ETFs remain the most efficient access point. Within them, financials, consumer sectors, and IT services stand out as relatively resilient, while exporters in textiles, gems, or solar should be approached cautiously until tariff normalization becomes clearer.

Currency remains the swing factor for global investors. The rupee could weaken further if export stress widens the current account deficit, or if energy prices spike. That makes currency-hedged India ETFs or USD-denominated ADRs attractive for investors with low risk tolerance. For those willing to absorb FX volatility, unhedged India exposures may deliver stronger long-term upside if INR stabilizes or appreciates alongside reforms.

Bottom line

India still deserves its premium place in global portfolios. The growth story remains unmatched in scale, and the structural tailwinds of demographics and digitization continue to compound.

But the investment case is no longer one-sided: tariffs, geopolitics, and rich valuations inject volatility into what is otherwise a powerful growth engine.

Investors should remain allocated, but tilt toward resilient domestic themes, manage FX exposure actively, and watch for tactical catalysts — from earnings upgrades to RBI rate cuts — that can turn volatility into opportunity.