Initial estimates of the NSO had pegged India’s GDP growth for Q1 FY2026 at 7.8%, materially exceeding expectations.
When Q2 had started, it seemed as if a large deceleration was on the cards, with signs of a slowdown in growth of government capex and unease related to US tariffs. However, the benefits of the GST rationalisation pushed up volumes in September, and we now project GDP growth for that quarter at 7%.
Manufacturing, led by consumer durables, will drive growth
We expect the manufacturing sector to have done quite well in Q2 FY2026, exceeding the expansion in the other sectors. As per the IIP data, the YoY growth in manufacturing output rose to a 7-quarter high of 4.9% in Q2 FY2026 from 3.3% in Q1, with the inventory stocking ahead of the festive season and GST rate cuts aiding volume growth, partly offsetting the adverse impact of steep US tariffs (and penalties).
In particular, the growth in consumer durables output witnessed a sharp upswing in Q2 vis-à-vis Q1. With a healthy YoY increase in operating profits of the manufacturing sector, as well as a low base, ICRA projects the manufacturing GVA growth to accelerate to 9.0% in Q2 FY2026 from 7.7% seen in Q1 FY2026.
Construction activity holds up well
On the construction front, input volumes suggest that the momentum held up in Q2 FY2026. The growth in finished steel consumption and other non-metallic mineral production, which includes items such as cement, bricks, tiles, and glass products, displayed an acceleration as compared to Q1, despite the interruptions from the above normal monsoon rainfall and episodes of disruptive flooding in some states through the quarter.
Government capex growth saw sequential improvement
However, the growth rate of the Government of India’s (GoI’s) gross capex moderated to 30.7% in Q2 FY2026 from 52.0% in Q1, although it was mainly attributed to the enlarged base. Likewise, based on the available data for 22 state governments, the aggregate capital outlay and net lending contracted by 4.6% in Q2, after the strong ~23% expansion in Q1 FY2026. However, the average monthly capex for both the GoI and states was higher in Q2 FY2026 vis-à-vis Q1.
Agriculture may be a drag
In contrast to the industrial segments, the growth in agriculture is expected to have eased slightly in Q2 FY2026. Although the early onset of monsoon and abundant rains supported kharif sowing, large excess rainfall and flooding in some parts of the country in late-August 2025 and early-September 2025 may have damaged standing crops. While kharif sowing exceeded last year’s area sown, the adverse base is anticipated to keep the agri-GVA expansion at around 3.5% in Q2 FY2026, similar to 3.7% in Q1 FY2026.
Services growth will be in line with headline GDP growth
On the services front, the YoY growth performance of six of the 10 high frequency indicators pertaining to the trade, transport and telecom segments, witnessed an improvement in Q2 FY2026 vis-à-vis Q1, including domestic CV sales, GST e-way bill generation, rail freight traffic, ports cargo traffic, diesel consumption and telephone subscribers.
Besides, premium hotel occupancy levels were firm in Q2, driven by business travel, meetings, incentives, conferences and exhibitions (MICE) activity, and leisure travel supported by some long weekends, despite heavy rains in certain parts of India. Sentiments have recovered from the temporary travel disruptions due to the terror attacks and geopolitical developments in the last quarter.
Among indicators pertaining to the financial sector, the incremental non-food bank credit (NFBC) surged to Rs. 8 trillion in Q2 FY2026 after remaining tepid at Rs. 2.1 trillion in Q1 FY2026, while printing only slightly higher than the year ago levels (Rs. 7.9 trillion in Q2 FY2025). This QoQ uptick can be attributed to banks becoming competitive compared to the bond markets as the yields in the bond markets increased while bank rates for fresh lending continued to decline in Q2 FY2026, aided by the transmission of the 100 bps policy rate cuts. Besides, the increase in economic activity following the announcement of the GST rate cut, likely spurred the demand for channel financing as well as retail loans, leading to a surge in credit flow in September 2025.
However, the YoY expansion in India’s services exports eased to a six-quarter low 8.7% in Q2 FY2026 from 10.1% in Q1 FY2026. Besides, the GoI’s non-interest revenue expenditure contracted by a sharp 11.2% YoY in Q2 FY2026, as against the 6.9% uptick seen Q1 FY2026. Additionally, the YoY growth in the combined non-interest revenue expenditure 22 state governments halved to 5.3% from 10.9%, respectively. Overall, ICRA expects the YoY growth in the services GVA to ease to 7.4% in Q2 FY2026 from the elevated 9.3% in Q1 FY2026.
GDP-GVA wedge likely to slip into negative territory
This sharp moderation in the services growth is set to pull down the overall GVA growth to 7.1% in Q2 FY2026 from the unexpectedly high 7.6% in Q1 FY2026, despite the favourable base. Interestingly, the GDP-GVA growth wedge is expected to flip back to the negative territory in Q2 FY2026, after a gap of two quarters. Based on the available data for the Centre’s indirect taxes and subsidies, ICRA estimates net indirect taxes (in nominal terms) to contract on a YoY basis in Q2 FY2026, after rising by 9.5% in Q1 FY2026, aided by the decline in indirect taxes of the GoI, amidst the narrowing in the contraction in subsidies.
As a result, ICRA expects India’s real GDP growth to print at ~7.0% in the quarter, ~10 bps lower than the GVA growth, and 80 bps below the 7.8% expansion seen in the previous quarter. Thereafter, unless the GoI’s capex allocation is enhanced and the tariff-related uncertainties ebb, the real GDP growth appears set to ease below 6.5% in H2 FY2026.
Deflator is expected to be low
Moreover, with low CPI and WPI inflation prints in the quarter gone by, the GDP deflator is likely to be quite low. As a result, nominal GDP growth would be quite similar to real GDP expansion, in Q2 as well as Q3 FY2026.
(Aditi Nayar is Chief Economist, Head- Research & Outreach, ICRA.)
Views are personal and do not represent the stand of this publication.
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