- Industrial output slows in Oct’25, as IIP drops to 0.4%
- India’s engineering exports fall by 16.7% y-o-y in Oct’25
India’s economy enters the second half of FY’26, with a mix of booming headline numbers and softening signals beneath the surface. The picture is neither euphoric nor alarming. It is a story of strong domestic engines, unusual inflation dynamics, a supportive policy push, and rising external headwinds that will shape the path forward.
Stronger-than-expected headline growth in Q2FY’26
Real GDP growth of 8.2% in the July-September quarter surprised almost everyone, given prevailing headwinds such as global geopolitical uncertainties. It was the fastest in six quarters and well above official and market forecasts. After a healthy 7.8% in Q1FY’26, India’s first-half growth stands at 8%. This led the Chief Economic Adviser and several private forecasters to lift their full-year projections to 7% or higher, with some estimates around 7.5%. If growth stays on track, India will likely cross the 4 trillion dollar GDP mark this fiscal year.
Behind the strong real number sits an important nuance. Nominal GDP grew only 8.7% in Q2FY’26, barely above the real figure. This happened because inflation collapsed. The GDP deflator for the first half is under 1%, and October retail inflation fell to a record low of 0.25%. With prices barely rising, the deflator inflated the real growth figure, even as underlying nominal momentum was more modest.
Even so, the broad nature of the expansion is real. Private consumption, which accounts for nearly 57% of GDP, grew 7.9% in Q2FY’26. Lower food inflation left households with more discretionary room, the GST rate cuts on mass-consumption items added support, and the festive season lifted urban spending. Government consumption, on the other hand, contracted as the Centre shifted its focus from revenue spending to capital expenditure.
On the supply side, manufacturing posted a strong 9.1% increase in gross value added (GVA). Lower input costs helped, as did front-loading of production ahead of US tariffs and festival demand. Construction remained solid, and services continued to carry the economy with double-digit growth in finance, business services, transport and communication. Agriculture, though stable, grew at a slower 3.5%.
Strong demand signals from firms, consumers
The strength of domestic activity has been visible in business surveys and tax data through most of the year. For 12 straight months, the composite PMI has stayed above 50, signalling expansion. It touched a high of 63.2 in August before easing to just below 60 by November. Services have led the momentum, often posting readings near or above 60. Manufacturing PMIs have been steady in the mid to high 50s.
GST collections reinforce the story. For a full year, monthly receipts have stayed above INR 1.67 lakh crore, with a record INR 2.10 lakh crore in April. The months after the GST 2.0 rate cuts still delivered around INR 1.7 lakh crore, even though headline growth slowed due to lower tax rates. Officials say the taxable value of supplies rose sharply in September and October, suggesting strong consumption, better compliance, and a broader base.
Soft patches under the surface
The optimism from headline GDP and PMI readings is tempered by rising pockets of stress.
Industrial output dipped sharply in October. The IIP grew just 0.4%, down from 6.2% in September.
Manufacturing slowed, and both capital goods and consumer durables declined. This points to softer investment demand and cautious discretionary spending. It also suggests that much of the earlier momentum was front-loaded, and the underlying cycle is weaker than the GDP headline suggests. PMI surveys still show expansion and rising employment, but manufacturing job creation has slowed to its weakest point in nearly two years.
The external sector adds another layer of concern. India’s engineering exports, a large and diversified category, fell 16.7% y-o-y in October. Shipments to the US dropped by 14.5% following reciprocal tariffs. Exports to ASEAN, the EU, and the UAE also weakened. The export boost from pre-tariff front-loading in Q2 is fading, and global demand conditions remain soft.
The current account deficit (CAD) widened to 1.3% of GDP in Q2FY’26, from 0.2% in Q1. Though still manageable, the rise reflects weaker financial inflows and a dip in forex reserves. A jump in gold imports in October could push the Q3 deficit above 2.5% before it begins to normalise. Strong services exports and robust remittances continue to provide a cushion, and most economists expect the FY’26 CAD to remain near 1.1 to 1.2% of GDP.
Govt’s fiscal balancing act
The government’s fiscal position shows a mix of ambition and constraint. The Centre has leaned hard on capital expenditure as a growth driver. Capex rose about 32% in the first seven months of the year to more than INR 6.17 lakh crore. This push is meant to crowd in private investment, strengthen supply chains, and support medium-term growth.
At the same time, net tax revenue has shrunk slightly in April-October, due to cuts in direct taxes, GST reductions, and higher transfers to states. The fiscal deficit has already crossed 52% of the full-year target. Some shortfall in tax collections is likely, though spending rationalisation may prevent major slippage. Rating agencies are watching closely, but for now, the market sees the situation as tight but manageable.
Policy puzzle: Low inflation, strong growth
The Reserve Bank of India faces one of the trickiest policy environments in recent years. On one hand, inflation is at historic lows, well below the 4% target. Real interest rates are high and tightening financial conditions. Industrial output shows clear signs of fatigue, and exports are under pressure. This argues for a rate cut.
On the other hand, the GDP headline is strong, the festive demand bump was real, and services activity remains robust. Some policymakers want to pause, reassess data quality given the unusual deflator, and preserve ammunition for future shocks.
Most analysts expect a dovish stance, either through a small cut or a prolonged pause, but no tightening. The central bank’s challenge is to support slowing pockets without overstimulating an economy that still shows solid momentum.
Outlook
Taken together, India’s growth story remains one of resilience. Domestic demand, especially in urban areas, is firm. Manufacturing and services continue to provide the backbone. Public capex, tax reforms, and better compliance have strengthened the base. Inflation has given the economy a window of stability that few other major economies currently enjoy.
But the margins are thinner. Exports face global headwinds and tariff shocks. Industrial output has lost steam. The external account will need careful management over the next two quarters. Fiscal space is tightening. And with real growth flattered by an unusually low deflator, the quality of growth will matter as much as quantity.
India is still on track to grow above 7% this year, and possibly reach the 5 trillion dollar level by the end of the decade. The challenge now is to keep the engines firing while addressing the soft spots early. The path is clear: steady public investment, a supportive but cautious monetary policy, stronger export competitiveness, and close attention to external risks.
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