Economy is resilient, the road ahead will be less forgiving

Why in the News

India’s Gross Domestic Product (GDP) grew 7.8 per cent in the first quarter of 2026-27, beating expectations for yet another quarter. The print exceeded the 6.8 per cent median forecast of professional forecasters and the Reserve Bank of India’s (RBI) revised projection of 7 per cent. The outperformance came from domestic drivers holding up in a global environment marked by conflict in West Asia and weather uncertainty. The tension is that the conditions that produced this print are turning. Crisil expects the growth-inflation mix to worsen through 2026-27, with growth moderating to 7 per cent and inflation rising to 5.1 per cent, and the balance of risks has shifted from rate cuts towards possible rate hikes.

What is the growth-inflation mix?

1. About: The growth-inflation mix is the combination of real output growth and the inflation rate an economy records in the same period. A favourable mix pairs high growth with inflation inside the RBI’s target band of 4 per cent, with a tolerance of 2 percentage points either side.
2. Why it matters for policy: The RBI sets the policy rate against this mix. Rising inflation alongside slowing growth forces a choice between tightening to contain prices and holding rates to protect activity.

What drove the first quarter outperformance?

1. Broad based domestic momentum: Robust industrial activity, healthy consumption and strong goods exports combined with accelerating government investment to drive growth. High-frequency indicators had signalled this momentum in advance.
2. Residual policy support and transfers: Policy measures introduced last fiscal continued to feed through, and direct benefit transfers expanded steadily. 17 States now provide cash transfers, primarily to women.
3. Goods and Services Tax (GST) rate cuts, visible in automobiles: Dealer discounts and higher disposable incomes from income-tax relief added to the effect of GST rate cuts. Eg. The Society of Indian Automobile Manufacturers (SIAM) reported first quarter sales growth of 26 per cent for passenger vehicles, 20.3 per cent for commercial vehicles and 18.3 per cent for two-wheelers.
4. Retail credit funding consumption: Other personal loans, a proxy for short-term consumption, grew 14.2 per cent.
5. Households shielded from crude: The government and oil companies absorbed most of the sharp rise in crude prices, particularly in the initial phase of the West Asia conflict, so household budgets did not take the hit.

Why will the growth-inflation mix turn less favourable in 2026-27?

1. Four sources of moderation: Growth will slow on disruptions from the West Asia conflict, unresolved tariff issues with the United States, weather-related risks and a strong base effect in the second half of the year.
2. Last year’s two tailwinds are gone: Low crude oil prices and a normal monsoon were the two exogenous factors that worked in India’s favour last year. Neither is expected to provide similar support this year.
3. The conflict’s cost channel: The West Asia conflict has disrupted supply chains and raised insurance, freight and input costs. This weighs on global and domestic growth at the same time.

Does a deficient monsoon still translate into food inflation?

1. The El Nino signal: El Nino conditions (a periodic warming of the equatorial Pacific that weakens the Indian monsoon) are intensifying. Over the past 25 years, five of the six El Nino years produced below-normal rainfall.
2. The deficit so far: Cumulative rainfall stood 14 per cent below the long-period average (LPA) at the end of August. July was 1 per cent above the LPA, and August recorded a deficit of 16 per cent. The India Meteorological Department (IMD) has signalled below-normal rainfall in September.
3. Irrigation has widened the cushion: India’s net irrigated area has risen by 10 percentage points to 59 per cent over the past decade, improving resilience to rainfall shocks.
4. Stocks exceed buffer norms: The country holds ample rice and wheat stocks. Foodgrain stocks currently stand at more than twice the buffer norms. That cushion contains price spikes.
5. Non-crop agriculture now carries the sector: Crop gross value added contracted by an average 0.5 per cent annually in the five years to 2023-24. Non-crop agriculture, now nearly 40 per cent of agricultural gross value added, expanded 6.5 per cent annually over the same period.
6. The historical record is not linear: Deficient monsoons have not always led to higher food inflation.
7. The vulnerability that remains: Crops without buffer stocks and perishable vegetables stay exposed to adverse weather. A weak monsoon also hurts rabi production by reducing soil moisture and lowering reservoir levels, so agricultural output and food inflation remain the key variables to watch.

Why does benign core inflation understate the price risk?

1. Headline eased, risks did not: Headline inflation eased in July and core inflation remained benign. Upside risks persist on three fronts, crude, input costs and demand.
2. The crude assumption: Crisil’s base case assumes Brent crude averaging $82 to 87 per barrel this fiscal, with the unresolved West Asia conflict keeping prices volatile. Higher crude translates into slower growth, higher inflation and a wider current account deficit.
3. Wholesale pressure is being passed on: Core inflation, a gauge of underlying demand pressure, appears deceptively low. Strong demand, rising fuel costs and other input pressures show up in near-double-digit wholesale price inflation, and are gradually being passed through to consumers.
4. Automobiles show the pass-through: Vehicle prices are set to rise as manufacturers protect margins and dealer discounts are withdrawn. Combined with a high base effect, this moderates automobile growth in the second half.
5. The rate cycle may reverse: Unlike last year, the balance of risks points towards possible interest rate hikes. Persistent inflationary pressure, the unresolved conflict and weather risk together bring monetary tightening back into consideration.

What still supports activity through the moderation?

1. External buffers: Foreign exchange reserves cover more than nine months of imports.
2. Balance sheet strength: Corporate and banking-sector balance sheets are in robust health.
3. Fiscal and wage support: Tax relief and public investment continue to support activity. The Pay Commission’s recommendations will add a further boost to consumption when implemented.
4. The structural condition: Beyond cyclical tailwinds, sustained progress on structural reforms that enhance competitiveness is the condition for maintaining growth momentum.

Challenges to sustaining the growth momentum

1. Export exposure to United States tariff policy: Unresolved tariff issues leave goods exporters unable to price contracts beyond a quarter. Eg. In August 2025 the United States raised tariffs on Indian goods to 50 per cent, half of it as a penalty tied to Russian oil purchases.
   The Fix: Conclude the bilateral trade agreement under negotiation and operationalise the Comprehensive Economic and Trade Agreement with the United Kingdom signed in 2025, so exposure to one market falls.
2. Crude dependence transmits every West Asian shock: India imports over 85 per cent of its crude, so a supply disruption raises the import bill, the fiscal cost of absorbing it and consumer prices together. Eg. About 40 per cent of India’s crude imports normally transit the Strait of Hormuz, and a large part of that supply has been offline since the disruptions of March 2026.
   The Fix: Widen the import slate to African, North American and South American barrels under term contracts and expand strategic petroleum reserve capacity beyond the present three sites.
3. Consumption leaning on one-off boosts: Income-tax relief, GST rate cuts and a Pay Commission award lift spending once, and the base effect then turns against growth. Eg. The HSBC India Manufacturing Purchasing Managers’ Index fell to a five-year low of 52.8 in August 2026, with the survey recording job losses for the first time in over two years.
   The Fix: Tie the next round of support to employment, through the Employment Linked Incentive scheme, so that income growth rather than tax relief carries consumption.
4. State cash transfers stretch State finances: A cash transfer to women is a recurring commitment that a State cannot withdraw without political cost. Eg. States’ aggregate fiscal deficit rose to 3.2 per cent of GDP in 2024-25, and only 11 States recorded a revenue surplus.
   The Fix: Ring-fence State capital expenditure under the Finance Commission’s fiscal roadmap so transfers do not crowd out investment.
5. A rate hike would hit credit-led consumption first: Retail borrowing has been funding short-term consumption, and it is the most rate sensitive part of demand. Eg. The RBI raised risk weights on unsecured consumer credit in November 2023 to slow exactly this segment.
   The Fix: Use targeted macroprudential tools on unsecured lending before resorting to a policy rate hike that would also raise the cost of investment.

Conclusion

India enters 2026-27 with a strong quarter behind it and a weaker mix ahead. The thing that cannot be settled yet is whether inflation will rise faster than growth slows, because that decides whether the RBI tightens into a moderating economy. The Monetary Policy Committee’s October meeting is the first decision point. The monsoon’s September outcome and the rabi sowing that follows will decide the food inflation half of the equation.

Key Facts about GDP Measurement

1. New base year: The GDP base was revised from 2011-12 to 2022-23, with the new series released on 27 February 2026. The Consumer Price Index base moved to 2024 and the Index of Industrial Production base to 2022-23 alongside it.
2. New data sources: GST data, the Public Financial Management System for central government accounts, e-Vahan for transport spending, and the Annual Survey of Unincorporated Sector Enterprises and the Periodic Labour Force Survey replaced proxy indicators.
3. Refined deflation: Double deflation (deflating output and inputs separately) now applies in manufacturing and agriculture, and single deflation has been discontinued.
4. Global alignment: The series aligns with the System of National Accounts 2008 and prepares for the transition to SNA 2025 by 2029-30.

Challenges in GDP Growth

1. Weak private investment: Capacity expansion depends on private capital formation, which has stayed subdued. Eg. Gross Fixed Capital Formation is around 30 per cent of GDP.
   The Fix: Scale the Production Linked Incentive scheme’s second phase and adopt Vietnam’s plug-and-play industrial park model to cut the time from approval to production.
2. Skill mismatch: Skills produced by the education system do not match what industry demands, so rising participation adds less output. Eg. Only about half of graduates are employable.
   The Fix: Expand Industry 4.0 training and emulate Germany’s dual education and apprenticeship system.
3. Participation gap: A large share of working-age women stays outside the labour force, capping the demographic dividend. Eg. The labour force participation rate is 59.3 per cent (2025), but the female rate is 40.0 per cent.
   The Fix: Deploy working women’s hostels and subsidised childcare on the model of Japan’s Womenomics.
4. Jobless growth: Output growth is concentrated in sectors that employ few people. Eg. Services contribute about 55 per cent of GDP but employ under 30 per cent of the workforce.
   The Fix: Implement Employment Linked Incentives and study China’s township and village enterprises for rural labour absorption.
5. Regulatory cost: Contract enforcement, clearance times and regulatory instability keep the cost of doing business above competitors. Eg. Logistics cost is near 8 per cent of GDP.
   The Fix: Emulate Singapore’s TradeNet single-window system to slash clearance times.

Matching Previous Year Question

“[2021, GS3, 10 marks] Explain the difference between computing methodology of India’s Gross Domestic Product(GDP) before the year 2015 and after the year 2015.”