India’s GDP Growth to Slow in FY25, Manufacturing and Financial Sectors Pose a Drag

India’s gross domestic product (GDP) is set to experience slower growth in FY2025, according to Nikhil Gupta, Chief Economist at Motilal Oswal Financial Services. Gupta predicts a deceleration in growth from the exceptional 8.2% recorded in FY2024 to approximately 6.1%, a figure notably below the Reserve Bank of India’s (RBI) projection of 7.2%. The economist attributes this expected slowdown primarily to challenges in the manufacturing and financial sectors, along with an unusual base effect from the previous fiscal year.

“The high growth in net indirect taxes, which was a key driver of the 8.2% GDP growth last year, is unlikely to sustain,” Gupta explains. In FY2024, the Gross Value Added (GVA) was 7.2%, significantly lower than GDP growth, indicating that the high GDP number was largely tax-driven. Gupta anticipates this gap will narrow in FY2025, with GVA growth expected to come in at around 6.3%, while GDP will likely trend closer to 6.1%.

The manufacturing and construction sectors, which benefitted from a deflator effect in FY2024 due to negative wholesale price index (WPI) inflation, are unlikely to see the same favorable conditions in FY2025. “The WPI deflator that boosted real growth last year will not be favorable this time around, especially for manufacturing,” Gupta notes. Additionally, services sector growth is expected to slow, as credit expansion may not be as robust as it was previously. However, agriculture could provide a buffer with better performance this fiscal year, following a weak showing in FY2024.

Consumption Patterns and the K-Shaped Recovery
Despite the overall slowdown in GDP growth, there is a positive trend in consumption. Gupta observes that real consumption growth, which was just 4% in FY2024—the slowest barring the COVID years—could pick up slightly to 5-5.5% this year. This growth, while modest, is still lower than historical levels, where aggregate consumption often expanded by 7-8%. However, Gupta believes that the direction of consumption growth is more important than the absolute number.

“The K-shaped recovery in consumption, where the wealthier segments of society benefitted disproportionately, might be narrowing,” he says. This recovery pattern was evident during the pandemic, where luxury goods and high-ticket items continued to perform well, while low-income groups struggled. Now, there are signs that this gap is closing, particularly in rural areas. Gupta anticipates that rural consumption, which has lagged behind urban consumption for the past two years, could outpace it in FY2025, driven by better agricultural output and improved income levels.

However, Gupta cautions that this narrowing of the K-shaped recovery is based on anecdotal evidence rather than concrete data. While it is clear that urban consumption has been strong, the real test will be whether rural consumption can sustain its momentum throughout the year.

Capital Expenditure and Long-Term Investment Growth
When it comes to capital expenditure (capex), Gupta offers a cautiously optimistic view. “Investment growth was significantly higher in FY2024, and we expect it to expand again in FY2025, albeit at a slower pace,” he says. Total investments as a percentage of GDP reached 33% last year, the highest in a decade, and this ratio is expected to remain flat over the next two years.

Capex, Gupta argues, is influenced by consumption trends but on a longer-term horizon. While consumption drives manufacturing investments, the effect is not immediate. “You cannot link capex to consumption on an annual basis,” he explains. Despite the expected slowdown in consumption and manufacturing growth, the overall investment environment remains positive, with infrastructure and public investments likely to support capex growth.

External Headwinds and Global Risks
One of the key risks to India’s economic outlook comes from external factors. Gupta highlights the uncertainty surrounding the global economy, particularly in the United States. “Everyone has been fearing a recession in the US, but so far, it hasn’t materialized,” he says. However, he remains cautious, noting that the prolonged period of high interest rates in the US has yet to fully impact consumer spending, capex, and employment trends.

While the US economy continues to defy expectations, Gupta warns that the effects of high borrowing costs could still materialize with a lag. “Higher mortgage costs should, in theory, reduce consumer spending and eventually impact investments, labor demand, and wage growth,” he explains. If this transmission mechanism begins to take hold, it could dampen global growth and, by extension, India’s export-driven sectors.

Geopolitical risks, particularly in the Middle East, add another layer of uncertainty. Rising oil prices, driven by geopolitical tensions, could increase inflationary pressures in India, which remains heavily dependent on oil imports. “If commodity prices, especially oil, start to rise sharply, it could create headwinds for both growth and equity markets,” Gupta warns.

Inflation and Rate Cut Trajectory
On the domestic front, inflation remains a concern. While inflation was below the RBI’s target of 4% in recent months, Gupta expects it to rise to around 4.5% by the end of FY2025. “This is still a manageable level, but it raises questions about whether growth can continue at the RBI’s projected rate of 7% with inflation hovering at these levels,” he says.

Regarding interest rates, Gupta forecasts a gradual easing by the RBI, with the first rate cut likely in early 2025, though a December cut cannot be ruled out. “Much will depend on the Q2 GDP data and global developments,” he adds. Gupta expects a cumulative rate cut of 100 basis points (bps) by the end of FY2026, with the first 25 bps cut potentially coming in FY2025.

Foreign fund flows into India are likely to remain strong, provided that India’s growth and corporate earnings continue to outpace other major economies. However, Gupta cautions that rising geopolitical risks and inflationary pressures could create volatility in equity markets, particularly if commodity prices surge.

In conclusion, while India’s growth prospects for FY2025 are expected to slow compared to the previous year, the economy remains resilient. Consumption trends are improving, particularly in rural areas, and investments are likely to remain stable. However, external risks, inflation, and the global economic outlook will continue to pose challenges in the months ahead.

The image added is for representation purposes only