Next quarters will be challenging as many distortions remain
By R. Suryamurthy
India’s economy has once again surprised on the upside. The first quarter of FY26 clocked a 7.8% expansion, a five-quarter high that has been hailed as evidence of resilience and momentum. In a world where global growth is sputtering, the figure drew applause as another data point in India’s much-narrated ascent.
Manufacturing grew by nearly 8%, services surged by over 9%, and private consumption expanded by 7%. Government spending also played a decisive role, with the Centre deploying nearly a quarter of its budgeted capital expenditure in just the first three months, while states front-loaded their own allocations. For headline writers, the numbers offered an irresistible story: India sprinting ahead even as others stumble.
Yet, scratch beneath the surface and the story looks far less assured. The quarter’s print was flattered by statistical quirks, frontloaded activity, and one-off supports. What lies ahead is more sobering. External shocks, fragile consumption, slowing nominal growth, and fiscal pressures threaten to turn this sprint into a stumble. The very factors that made Q1 shine could become drags in the second half of the year.
The most striking distortion comes from the GDP deflator—the measure that adjusts nominal output for inflation. With wholesale and consumer inflation sharply lower, real GDP looks larger even though nominal GDP slowed to 8.8% from 10.8% in the previous quarter.
In essence, the economy did not create dramatically more value in rupee terms; falling prices made the same activity appear bigger. This “deflator dividend” exaggerates growth when inflation dips, and shrinks it when prices rise. Policymakers know well that nominal GDP matters more for revenues, debt servicing, and corporate performance. A slowdown from double-digit to single-digit nominal growth is no trivial matter—it means fewer taxes collected, weaker earnings, and more stress on balance sheets.
Exports boosted the Q1 print, but for reasons that are unlikely to endure. Shipments were frontloaded to beat looming tariffs, with goods to the US surging more than 20% in the April-July period.
Now that steep bilateral tariffs are in force, exporters face a very different reality. Labour-intensive sectors such as textiles, apparel, and leather—already operating on razor-thin margins—face the prospect of being priced out of key markets. Some firms may withdraw from global competition altogether, cutting not just output but also employment. The fallout is not confined to factories; it will ripple into small towns and villages where export-linked livelihoods dominate.
The damage from trade friction extends beyond volumes. Once global buyers shift supply chains, regaining lost share is far harder than losing it. India’s exporters, who already struggle with logistics costs and regulatory hurdles, could find themselves permanently sidelined. The Q1 export surge, in this light, looks less like a sign of resilience and more like a last hurrah before the drag sets in.
On the fiscal side, both the Centre and state governments pressed the accelerator early in the year. Nearly a quarter of the Centre’s budgeted capital expenditure was spent in Q1, complemented by aggressive state spending. The intent was clear: keep growth buoyant, signal infrastructure momentum, and cushion the blow from upcoming tax cuts.
This strategy worked in the short term. Construction activity was robust, cement and steel production rose, and headline growth received a substantial lift. But the sustainability is questionable. With tax giveaways now locked in, and direct tax receipts already underperforming, fiscal space will narrow in the months ahead. The room to repeat the Q1 splurge simply does not exist.
Moreover, state finances remain stretched. Rising borrowing costs and shrinking revenue buoyancy will force them into consolidation. What looked like an investment surge in Q1 may flatten into a plateau by year-end.
Private consumption, the backbone of the economy, posted a healthy 7% rise. Rural India, long the weak link, finally showed signs of life. Rising real wages, better farm incomes, and stronger FMCG sales suggested a revival. Lower demand for make-work schemes like MGNREGA hinted that labourers were finding more remunerative work elsewhere.
But urban India tells a more worrying story. Wage growth has stagnated in real terms. Vehicle sales slipped after a strong festive season last year. Electronic payments—often a proxy for consumer activity—slowed. Discretionary spending on travel, restaurants, and lifestyle products softened. In other words, the consumption recovery is narrow and fragile, driven more by rural momentum and agriculture, sectors acutely vulnerable to monsoon swings and commodity price cycles.
The unevenness is striking. While rural India climbs back after years of distress, urban households, especially in middle-income brackets, are tightening belts. If the rural boost falters due to patchy rainfall or falling crop prices, the consumption story could lose its only reliable leg.
Gross Fixed Capital Formation grew in line with expectations, but the driver was almost entirely the state. The Centre and states delivered the bulk of the push through infrastructure projects, highways, and public works.
The private sector, by contrast, remains cautious. Credit growth to the industry has slowed markedly. Corporate balance sheets may be healthier than a decade ago, but risk appetite remains weak. Uncertainty about global demand, tariff wars, and domestic demand fragility keeps boardrooms hesitant. The much-touted “crowding in” of private investment following public spending has yet to materialise.
Without private sector conviction, India risks an unbalanced investment cycle—one where government builds, but industry does not follow. Public capex may lift quarterly numbers, but durable capacity expansion requires corporate participation. The Q1 data underscores that this link is still broken.
Services accounted for more than two-thirds of incremental growth, led by financial, real estate, professional services, and trade, hotels and transport. Tourism and pent-up demand for travel played their part, while housing loans and real estate activity added heft.
Yet, here too, distortions abound. Deflators in services fell sharply, artificially boosting real growth. The sharp rise in financial services is difficult to reconcile with slowing credit expansion. If service growth rests partly on statistical quirks, its sustainability is doubtful. A slowdown in discretionary spending and rising stress in urban demand could quickly expose the fragility.
The most immediate roadblock is trade. Imports rose faster than exports in Q1, leaving net exports flat in contribution. With tariffs now fully operational, export momentum will likely weaken further.
The sectors most at risk—textiles, apparel, gems and jewellery, leather, and light engineering—employ millions, especially women and low-skilled workers. Their vulnerability to higher tariffs threatens not just growth numbers but social stability. As order books shrink, layoffs and wage cuts are inevitable, feeding back into weaker consumption.
Add to this the risk of oil price volatility, geopolitical disruptions, and slowing global demand, and India’s external environment looks more perilous than supportive. The global tailwinds of the post-pandemic rebound are gone; what remains are headwinds of protectionism and fragmentation.
Fiscal space is tightening just as the economy faces these shocks. Tax cuts framed as reforms will shave tens of thousands of crores from revenues. Direct tax growth is already lagging. Disinvestment receipts remain negligible. The cushion that allowed a capex surge in Q1 will not be as easily available later.
On the monetary side, the strong Q1 print has likely pushed back immediate rate cuts. Markets have already priced out easing in October. But if growth weakens under tariff pressure, the central bank may be forced to act later in the year, juggling between inflation risks and slowing activity. Unlike last year, both fiscal and monetary policy enter the second half with less flexibility.
The consensus expectation among economists is that growth will settle closer to 6.5% for FY26, far below the Q1 pace. The reasons are clear: Tariffs and trade friction will sap exports and jobs. Weak nominal GDP undermines revenues and corporate earnings. Consumption remains fragile, with urban demand softening. Private investment lags, leaving growth over-dependent on the state. Fiscal strain from tax cuts reduces policy space.
The 7.8% figure is a sprint, not a stride. It reflects momentum built on statistical quirks, policy frontloading, and temporary tailwinds. The road ahead is far less smooth.
India’s economy is not stagnant, but neither is it invincible. The challenge is not celebrating one quarter’s sprint but sustaining growth through headwinds. Without structural reform to unlock private investment, diversify exports, and broaden consumption, the economy risks running into the very speed breakers its Q1 numbers seemed to defy. The growth story must shift from optics to substance. Otherwise, what looks like resilience today may be remembered tomorrow as overconfidence before the slowdown hit. (IPA Service)
