Growth could taper off after large Q1 upside

We are apprehensive that GDP growth will taper off in the coming quarters from the unexpectedly high 7.8% seen in Q1 FY2026.

The Q1 FY2026 GDP growth delivered an outsized surprise, accelerating to a five-quarter high of 7.8% from 7.4% in Q4 FY2025. This was in contrast with ICRA’s expectations of a slowdown to 6.7%, as was signalled by most high frequency indicators and earnings numbers. The GVA growth also rose to 7.6% from 6.8% in the previous quarter, although the wedge between the two measures expectedly narrowed to 18 bps from 62 bps, respectively.

Manufacturing and Services Lead the Way

This positive surprise on the GDP growth print in Q1 FY2026 was largely driven by the manufacturing sector, which witnessed a very sharp pickup in its growth to a five-quarter high 7.7% from 4.8% in Q4 FY2025, even as the volume growth for the sector, as reflected in the manufacturing IIP, decelerated between these quarters.

Besides, the growth in services GVA rose sharply, printing above 9% after a gap of seven quarters, with an unexpectedly sharp acceleration in the finance, real estate and professional services segment.

In contrast, the agriculture and mining sectors underperformed our forecasts for the quarter, with the former witnessing a healthy growth of 3.7%, and the latter contracting by 3.1%, led by a fall in mining output volumes owing to excess rains in June 2025.

Concerns Over Domestic and Global Uncertainties

On the expenditure side, the growth in the Private Final Consumption Expenditure (PFCE) improved to 7.0% in Q1 FY2026 from 6.0% in Q4 FY2025, while printing in line with the run rate of 7.2% over the last four quarters. This improvement may have been driven by healthy rural demand, which has been aided by favourable crop outcomes, even as urban consumption likely remained uneven. We remain circumspect regarding the robustness of the PFCE numbers, which have suggested that consumption demand grew at a solid pace through FY2025, even as the general commentary by consumer-oriented companies suggested otherwise. This data could undergo sizeable revisions when the quarterly estimates for Q3 and Q4 are released.

Investment activity remained quite strong in Q1 FY2026, with the Gross Fixed Capital Formation rising by a healthy 7.8% in the quarter, even though this was slower than the 9.4% growth seen in Q4 FY2025. The Government of India’s (GoI) capex had surged by over 50% in the quarter, which is likely to have supported investment demand, even as private capex is likely to have been sluggish owing to the heightened global uncertainty. Besides, Government Final Consumption Expenditure (GFCE) expanded by a healthy 7.4% in Q1 FY2026, after contracting in the previous quarter, reflecting the trends in the GoI’s non-interest non-subsidy revex.

Key Drivers for the Economy

While the latest GDP data confirmed that Q1 FY2026 was a strong quarter for growth, the path ahead appears clouded by multiple uncertainties. Moreover, some indications of tepidness have already emerged. For instance, after surging in Q1 FY2026, the GoI’s capex contracted in July 2025. Heavy rains have kept mining and electricity output growth weak as well so far in this quarter.

On the tariff front, the US has imposed the 25% additional penalty on India on August 27, 2025, taking the total tariff to 50%. The most vulnerable sectors to the US tariffs are textiles, cut and polished diamonds, seafood, leather products, while pharma, petroleum products, electronic goods like smartphones are exempted. Considering that ~50-60% of India’s exports to the US (total merchandise exports to the US in FY2025: $87 billion) are at risk, the downside is likely to be material in case the 50% tariff rate (25% general + 25% special) is continued until the end of FY2026. Given this, India's exports to the US are likely to contract during the remainder of the fiscal, which would weigh on the GDP growth prints. Moreover, potential job losses in export-oriented sectors might sour consumption sentiment in some pockets.

Given the strong onset in April-July FY2026, the GoI’s capex target of Rs. 11.2 trillion for FY2026 implies a contraction of ~2.0% in the remaining part of the fiscal, unless additional capex is undertaken. If some amount is allocated towards a special package for exporters via supplementary demand for grants, it would increase GoI’s non-interest revex, thereby auguring well for the GVA-PADOS segment. Nevertheless, private capex plans would be delayed, until there is more clarity on tariffs, demand certainty, etc.

The GoI’s proposal for ‘Next Generation GST reforms’ by October 2025 (before Diwali) would certainly aid consumption of household goods including daily essentials, packaged food items, apparel, footwear, consumer durables like ACs, TVs, and refrigerators as well as automobiles, especially in the entry level segment. However, this may lead to some deferment in consumption of these items in the run up to the upcoming festive season, as consumers wait until the tax cuts are implemented. Nevertheless, the GST rejig, once implemented, would provide a thrust to household consumption, amid the favourable setting of lower interest rates and income tax relief.

Overall, we are apprehensive that GDP growth will taper off in the coming quarters from the unexpectedly high 7.8% seen in Q1 FY2026. To record a growth rate of 6.0% in FY2026, which remains our baseline expectation, the economy needs to expand by 5.5% in the last three quarters of this year. While this might seem puny given the 7.8% expansion in Q1, it remains a tall ask in the context of the tariff shock.

(Aditi Nayar, Chief Economist, Head- Research & Outreach, ICRA.)

Views are personal and do not represent the stand of this publication.