OPINION | Growth surprises on the upside again; chance of rate cut recedes

The economy accelerated for the fourth quarter in a row.

After the stronger-than-expected GDP growth print for Q1 FY2026, market participants had broadly expected some deceleration in Q2, even as most (including us) projected growth to remain in the 7% handle. However, the initial estimate of the NSO provided yet another positive surprise, with a robust print of 8.2% for Q2 FY2026. This stands out on multiple counts.

An 8%+ growth after five quarters

Firstly, the economy accelerated for the fourth quarter in a row. Secondly, GDP growth exceeded 8% after a gap of five quarters.

On the expenditure side, the growth in Private Final Consumption Expenditure (PFCE) accelerated to 7.9% in Q2 FY2026 from 7.0% in Q1, pushing up the GDP growth print by as much as 43 bps between these quarters. This was to be expected, after the commencement of the GST-fuelled consumption bonanza in the festive season; the latter witnessed an earlier onset in 2025 than the previous year, and therefore benefitted from a relatively low base.

Interestingly, PFCE was the only expenditure side component that registered an uptick in sequential growth rates; all the other components witnessed a deceleration, exerting a drag on the headline print. For instance, while government final consumption expenditure (GFCE) expectedly contracted in Q2 (by 2.7%; +7.4% in Q1), led by weak Government revenue spending, the pace of rise in gross fixed capital formation also moderated between these quarters (to +7.3% from +7.8%).

Impact of discrepancies

Moreover, the pace of growth in all components, including PFCE, trailed that seen in the GDP growth print. This surprising phenomenon can be explained by a flip in discrepancies to a large positive number from a negative print in Q2 FY2025.

PADOS segment surprises in GVA calculation

Among the production side components, the growth in services was surprisingly high at 9.2% in Q2, only marginally lower than the 9.3% in Q1 FY2026. This was driven by the inexplicably high expansion in the Public Administration, Defence and Other Services (PADOS) segment. The growth in this sub sector was expected to decelerate sharply in the quarter, amid the double-digit contraction in the non-interest revenue expenditure of the Government of India (GoI) and moderation in the growth of the same for the states, relative to Q1. This accounted for much of the upside surprise relative to market estimates for the headline GDP growth print in the quarter.

Manufacturing and construction put up a good show

The growth in the industrial sector rose to 7.7% in Q2 from 6.3% in Q1 FY2026, in line with our projections, aided by a low base across most segments. Manufacturing expectedly did quite well, with the GVA growth in the same printing at 9.1%, also mirroring the trends seen in volumes, as reflected in the IIP. Further, construction activity remained buoyant, with the growth in the same printing above the 7% mark for the twelfth consecutive quarter.

While the YoY performance of electricity and mining also improved in Q2 relative to Q1, growth rates remained quite lacklustre. Agriculture and allied activities displayed a steady growth momentum post the broadly healthy monsoon.

GDP in FY26 likely to be around 7.4%

With the real GDP growth having averaged 8.0% in H1 FY2026 despite the tariff related uncertainty, we have revisited our expectations of the level of expansion that is likely in the coming quarters. In our view, headwinds on account of an adverse base, the potential negative impact of US tariffs and lower headroom for capital spending by the Government of India (vis-a-vis its FY2026 Budget Estimates) would likely moderate the pace of growth.

However, the pace of real GDP growth in FY2026 now appears to be around 7.4%, much higher than the 6.5% seen in the previous year.

Deflator’s impact on nominal GDP

Interestingly, while real GDP growth accelerated to a 6-quarter high of 8.2% in Q2 FY2026, nominal GDP growth decelerated to a 4-quarter low of 8.7% from 8.8% in the previous quarter. This is explained by the slump in the GDP deflator (+0.5%) to the lowest level in 24 quarters.

Looking ahead, owing to the expectation of GST rationalisation-induced softening in Q3 CPI inflation as well as deflation in WPI, the GDP deflator is likely to be low in Q3 FY2026 as well. As a result, nominal GDP growth would be quite similar to real GDP expansion in the ongoing quarter. Thereafter, with the CPI and WPI set to display a base effect-led acceleration in their inflation rates in Q4 FY2026, the GDP deflator would rise sharply in that quarter.

Consequently, nominal GDP expansion would be materially higher than the real GDP growth print in Q4 FY2026.

Overall, given the muted outlook for inflation, we expect the nominal GDP growth to slow to ~8.5% in FY2026 from 9.8% in FY2025, the lowest level in the post-Covid period, even as real GDP growth is set to accelerate between these years.

Rate cut chance recedes

What does all this mean for monetary policy? Looking ahead, we expect the real GDP growth to ease in H2 FY2026 while remaining healthy, even as base normalisation would harden inflation in Q4 FY2026 and early FY2027, albeit to range-bound levels. With the Q2 FY2026 GDP growth exceeding 8%, as against the Monetary Policy Committee’s (MPC’s) last forecast of 7.0% for this quarter, the likelihood of a rate cut in the upcoming December 2025 MPC review has definitely dipped, in spite of the series-low CPI inflation print for October 2025.