India's domestic growth looks steady, but external risks are a key concern

The national accounts data, released last week, surprised most economists positively. Gross domestic product (GDP) in the fourth quarter of 2004-25 grew 7.4 per cent, taking the full-year growth rate in real terms to 6.5 per cent, as was projected by the National Statistics Office in its second advance estimates. A sharp drop in the second-quarter growth rate to a sub-6 per cent level had raised concern.  However, the economy recovered in the second half of the year, particularly in the last quarter. Growth in gross value added, at 6.8 per cent during the quarter, was driven by sectors like agriculture, construction, and services. The manufacturing sector remained a drag, growing only 4.8 per cent during the quarter. On the demand side, for the full year, private final consumption expenditure increased 7.2 per cent as against 5.6 per cent in the previous year, while investment expanded 7.1 per cent compared to 8.8 per cent in the previous financial year. The year began with sluggish investment activity, but it gained momentum in the second half. 

Even though growth came in at 6.5 per cent, it is worth noting that this marked a sharp deceleration from the 9.2 per cent recorded in 2023-24. Besides, the year witnessed the slowest pace of expansion since the recovery from the pandemic began in 2021-22. Several economists had argued during the year that growth had returned to its normal level after recovering from the pandemic shock. For the current year, the agricultural sector is expected to perform well. The monsoon has arrived early and it is projected to be above normal. Higher agricultural production will not only directly contribute to growth but also boost rural incomes, which in turn will support demand. Overall, although private consumption showed signs of revival, its sustainability remains to be tested. Nonetheless, higher agricultural output and lower food inflation will allow the Monetary Policy Committee (MPC) to ease policy. 

Analysts expect the MPC to reduce the policy interest rate by another 50 to 100 basis points in this cycle. Reduction will depend on how the MPC expects inflation conditions to evolve in the coming quarters and its assessment of the potential growth. If inflation outcomes remain close to the target, the MPC may want to push growth with policy accommodation. However, a lot will depend on how the external environment unfolds. Higher bond yields in the United States (US) and elsewhere may also influence the MPC’s choices. In fact, external financial and economic uncertainties will affect the Indian economy in multiple ways. A US court has ruled to block higher tariffs imposed by the Donald Trump administration under emergency powers. However, another court has given it temporary relief. Meanwhile, Mr Trump has announced a doubling of tariffs on steel and aluminium. 

The global trade and economic uncertainties unleashed by the Trump administration are likely to persist, even as countries negotiate trade agreements with the US. It is unlikely that Mr Trump will give up his tariff plans, and the legal complications will only add to the uncertainty. In such a situation, exports and investment could be affected, with implications for growth. Last week’s data also showed that the government met its fiscal-deficit target for last financial year. It will be expected to do the same this year. Higher allocation for capital expenditure should continue to support growth this year too. Thus, the biggest risks to growth in the current year will be external. How India navigates this environment and implements reforms to improve the business climate will shape its medium-term growth trajectory.