India’s economy grew by a stronger-than-expected 7.8% in the April-June quarter, its fastest pace in five quarters. This came as US President Donald Trump imposed tariffs that now cloud the outlook, threatening key exports like textiles.
HSBC pointed out that the services sector deflator is more closely aligned with the wholesale price index (WPI), which is goods-heavy, rather than consumer price inflation for services.
When commodity prices fall and manufacturing inflation drops, this method understates price rises in services, thereby inflating real growth.
“We find that CPI services inflation for the quarter was 3.4%, higher than the 1.9% GDP services deflator used. If we switch to the former, real services growth falls by 1.5 percentage points, and GDP growth falls by about 0.8 percentage points,” HSBC analysts noted.
India currently uses single deflation, meaning it adjusts only output prices without accounting for changes in input costs. In periods when commodity prices fall, this can exaggerate manufacturing growth.
Chief Economic Advisor (CEA) Anantha Nageswaran also acknowledged the deflator’s impact on last quarter’s growth.
“I think the first quarter numbers for the fiscal year were definitely better than expected. A lot of people attributed the fact that the GDP deflator was much weaker this year compared to last year… in some sense, the GDP deflator being on the weaker side was a good thing and was not an unknown aspect. That was factored into the consensus expectations of Indian economists in the private sector,” Nageswaran added.
HSBC further said that in FY16, a sharp fall in oil prices led to manufacturing growth being overstated by nearly four percentage points. This time, it estimates the exaggeration could be around 1.5 percentage points in manufacturing growth and about 0.2 percentage points in headline GDP.
Quanto Eco Research, another research house, also attributed the low deflator as one of the factors for sharp growth in India’s GDP but didn’t provide estimates. Other contributing factors include strong government capex, front-loaded manufacturing ahead of US tariffs, a good monsoon—and a low deflator.
DBS noted that deflators narrowed sharply in the quarter to 1% from 3.4% earlier, magnifying the real growth figure, especially in services which reported growth of 9.3%.
Low deflators usually impact the calculation of real GDP. Nominal GDP is adjusted for inflation to derive real GDP. If the deflator used is too low, inflation is understated, making real growth appear stronger than it actually is.
India’s growth surprise has been cheered by markets. With external headwinds in the form of US tariffs and revenue pressures from GST rationalisation, economists say it is important to see whether growth momentum is sustainable.
Outlook
BS Bank said the focus now shifts to the drivers in the remaining three quarters of the year, where two-way forces are likely at work.
“Demand-accretive measures by way of rationalisation in GST rates might benefit consumption, but push the boost to 3QFY rather than the festive 2Q. Add to this a gradual transmission of rate cuts and directed fiscal support to affected businesses, which will also be timely,” the bank noted, adding that the deflator impact will show in the second quarter as well when WPI and CPI gapped down.
The tariff impact
Economists note that the impact of tariffs on growth will hinge on their duration.
“There were two parts to the US tariffs. Both will have an impact in the second quarter and possibly a little into the beginning of the calendar fourth quarter or the fiscal third quarter. I think some of these tariff measures will be short-lived and there are a lot of conversations going on between India and the US government. I do believe that a resolution will be found sooner rather than later,” Nageswaran said.
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