The Macroeconomy and Capital Markets: A Medium-Term Outlook

The past few months have brought heightened volatility across global markets – a sharp correction followed by a partial recovery even as underlying risks continue to weigh on investor sentiment. Uncertainty remains high, particularly around trade flows, inflation and geopolitics. At a recent India CEO Forum session in Mumbai, Neelkanth Mishra, Chief Economist at Axis Bank and Head of Global Research and WTD at Axis Capital, shared his perspective on how current macroeconomic conditions may play out in the Indian and global context. He discussed the market outlook, potential shocks at the macro level and key trends in currency, trade and capital flows.

Global Rebalancing: Fiscal Priorities and Power Shifts 

The US, with 5% of the world’s population, accounts for 25% of global GDP and 50% of global defence spending. Europe, with a comparable population, spends disproportionately more on social welfare and less on defence. This imbalance, previously underwritten by American security guarantees, is now being renegotiated. NATO allies are beginning to align with US demands, raising defence spending to 3.5-5% of GDP, which could worsen Europe’s fiscal constraints while potentially triggering political unrest. In many ways, the US remains the anchor of global demand, attracting ~60% of net foreign savings. Yet, its reserve currency status, which allowed it to run sustained current account deficits, is under threat. After decades of irresponsible fiscal expansion, America’s net international investment position has deteriorated from -20% of GDP in 2010-12 to nearly -90% today. This shift has triggered calls for a weaker dollar. Real Effective Exchange Rate (REER) data indicate that the dollar is now as overvalued as it was before the 1971 ‘Nixon Shock’ and the 1985 Plaza Accord – both periods that preceded sharp devaluations of 30-38%. While the US has historically managed to sustain large CADs, the likelihood of this continuing indefinitely is low, given growing internal fiscal pressures and shifting global dynamics. A sharp dollar depreciation is likely sometime in the next 3-5 years, though its timing is uncertain. 

Trade Friction, Industrial Policy and a Fraying Multilateral Order 

Donald Trump’s trade policy marks a shift toward a new form of economic nationalism, where import tariffs are no longer just trade tools, but fiscal levers. This is evident, for instance, in proposed duties of up to 25% of Japanese and Korean auto imports. In fact, the current US administration seems to be harking back to an era, prior to WWI, when as much as 50% of US government revenue came from tariffs. Whether this goal is realistic remains to be seen, but it appears unlikely. It is also incompatible with the aim of making American manufacturing ‘great again.’ However, rising protectionism is not limited to the US, and industrial policy is reemerging globally, though enforcement challenges persist. The net result is massive uncertainty in the policy making process, across the globe. 

Increasingly, markets are pricing in the derisively-termed ‘TACO trade’: bold tariff threats followed by tactical retreats in response to market stress. This is evident in the way recent tariff measures are being communicated. By initially proposing extreme duties ranging from 140-150%, the final negotiated figures are being positioned as a ‘success’, even though they are well above the previous baseline levels. For instance, duties on Chinese imports are now expected to settle around 40-45%, up from less than 10%. This pattern of dialling back from extreme positions to secure acceptance of still-stringent measures creates a perception of policy moderation, when in fact the outcome represents a structural increase in trade barriers. Depending on where final rates settle, the US government could generate additional revenues equivalent to 0.1-0.3% of GDP.  

Companies – and countries – are doing their best to circumvent rising trade barriers. This is evident in trade data discrepancies, such as a USD 110 billion gap between US import records and Chinese export data, which suggests rampant under-invoicing. Regardless of what the official numbers say, the reality is that China has continued to export to the US in large volumes, albeit circuitously. More and more Chinese companies have been trans-shipping to the US via Vietnam, Malaysia, Morocco, Hungary, Mexico and even India. America has belatedly caught on to this trend and is now working to close these ‘trans-shipping routes’ – evident in its recent trade deal with Vietnam. 

Beneath these global policy changes lies a deeper problem: in real terms, income at the bottom of the pyramid has been stagnant for decades. In the US, people without college degrees have seen little improvement in their incomes or quality of life in the last 30 years, and life expectancy for this group has also fallen behind that of the rest of the population. The frustration this created is what  fuelled Mr Trump’s rise, as well as support for protectionism. Today’s industrial policy is, in part, trying to fix these issues, but the goals often clash. Governments want to bring back jobs, reduce inequality, control inflation and manage fiscal pressures, all at the same time. With so many conflicting objectives and political pressures, the result is confusion and short-term fixes, rather than a clear long-term strategy. 

Looking ahead, currency battles loom large. The Chinese yuan has depreciated by 18% over three years, while China has had near-zero inflation and substantial capital flight (USD 1.4 trillion over a decade in ‘errors and omissions’). Meanwhile, inbound FDI into China has collapsed and balance of payments is under strain despite a large goods trade surplus. 

India's Resilience and Strategic Path Forward 

Amidst all this chaos, India’s economic position is one of comparative resilience. Despite undertaking significant fiscal consolidation – 80 basis points per year for two years and a further 40 bps this year –India has maintained GDP growth at over 6.5%. With inflation falling and the RBI injecting liquidity, monetary easing is now being accompanied by improved credit transmission. (Until recently, tight liquidity meant that borrowing costs were rising and not falling. Despite policy rate cuts, the intended easing was not being passed through to businesses and consumers.) Only with the recent liquidity support has the transmission mechanism begun to function more effectively. Government bonds have fallen to a 6.2% yield and AAA-rated corporate bonds are being priced at historically low spreads. Meanwhile, India’s capital markets are seeing robust inflows. Over Rs 260 billion of domestic funds are entering the equity market monthly, including from 110 million SIP accounts and provident fund allocations. However, supply lags demand, creating elevated valuations. IPO activity is rising, enabling risk capital formation while avoiding asset bubbles. 

Reforms and the Domestic Demand Imperative 

In order to sustain or even accelerate GDP growth, India must pivot even more strongly toward domestic demand. Even if India grows to a USD 20 trillion economy, no more than USD 1 trillion of this growth will come from net exports, underscoring the need to stimulate internal consumption and investment. Unlike the export-led models of the past, India’s structural and geopolitical realities suggest that most growth will have to come from within. Urbanisation will play a central role in this transformation. Real estate, urban infrastructure and tier-2/3 city development will be crucial, along with strengthening state and local governance. To help drive this, states like Maharashtra, Tamil Nadu and Uttar Pradesh are creating industrial land banks and easing regulations. 

Demographic advantages are another strength. India can potentially export labour – both blue and white collar – creating not just remittance inflows, but also longer-term expertise and capital. Organised worker migration to countries like Japan, Germany and Italy is accelerating and could become a structural contributor to India’s consumption growth. As legal migration becomes more systematised globally, this channel is likely to expand meaningfully over the next decade, providing a durable source of domestic demand. 

In terms of emerging industries, there is a need to transition India from a service-driven to a product-driven economy, particularly in areas like semiconductors, electronics and defence. In this regard, South Korea and Taiwan are great examples of how public-private partnership can enable R&D, risk capital and domestic tech sovereignty. To achieve this shift, India must address key ecosystem gaps. Risk capital remains scarce, and academic research output in high-tech fields is limited. Building a robust innovation and manufacturing ecosystem will require long-term investments in talent, venture capital and institutional depth. Importantly, the government’s role must remain that of an enabler creating the right conditions for the private sector to drive innovation, investment and scale.