India's economy grew a stronger-than-expected 7.8 per cent in the first quarter of FY26, but economists caution that the growth print looks brighter than the underlying reality — thanks largely to a sharp drop in the GDP deflator from 3.4 per cent in the previous quarter to 1 per cent in the Q1 of FY26, the lowest in 6 years.
The GDP deflator, which adjusts nominal GDP for inflation, fell sharply as both the wholesale price index (WPI) and the consumer price index (CPI) inflation moderated in April-June. This pushed real GDP growth higher, even as nominal GDP growth slowed to 8.8 per cent from 10.8 per cent in the previous quarter.
"The slowdown in inflation has provided double support to real GDP, first by slowing the deflator growth and second by supporting producer margins via lower input costs," said Gaura Sen Gupta, Chief Economist at IDFC First Bank. She added that subdued direct tax collections, weak corporate sales growth, and soft credit expansion suggest nominal GDP may be a more accurate gauge of underlying economic momentum.
The impact of the low deflator was particularly visible in the services sector, which grew 9.3 per cent year-on-year compared to 7.3 per cent in the previous quarter. "Deflators narrowed considerably in the quarter (1 per cent vs 3.4 per cent earlier), reflecting the sharp slowdown in WPI and CPI inflation numbers. This was most evident in the heavy-weight service sector performance," said Radhika Rao, Executive Director and Senior Economist at DBS Bank.
Economists warn that this technical boost may fade. "The super growth surprise of 7.8 per cent emanates from an extremely soft deflator-led technical boost," said Madhvi Arora, Chief Economist at Emkay Global. "Nominal GDP has already dropped to 8.8 per cent, and we expect it to slow further to 7.6-7.9 per cent in FY26, which has serious implications for tax collections, fiscal deficit, and corporate earnings."
The divergence between nominal and real GDP growth also highlights the fragility of the recovery. While corporate profits have benefited from lower input costs, topline growth remains tepid. Arora cautioned that "this divergence between revenue/sales and profit margins will eventually converge, further impinging on the growth story."
Looking ahead, economists expect the deflator to rebound in the second half of FY26 as inflation picks up. "The Q1 print was supported by transient factors such as base effects, deflator slowdown, front-loading of exports and government capex. These factors will reverse in H2FY26, dragging growth lower," said Sen Gupta of IDFC First Bank, revising her FY26 GDP growth forecast up to 6.6 per cent from 6.3 per cent earlier.
DBS's Rao added that deflator effects would continue to show in the second quarter, but that tariff-related risks and weaker global trade could weigh on momentum thereafter.
Despite the eye-catching Q1 GDP number, economists agree the low deflator has flattered growth, making nominal GDP a better barometer of underlying conditions. As Sen Gupta put it: "Nominal GDP may be a better indicator of growth, given the slowdown in direct taxes and credit."