India’s inflation dynamics pose a puzzle. Despite several years of above-potential gross domestic product (GDP) growth, underlying inflation fell to record lows (before the West Asia war).
Does this mean India can grow rapidly, barring oil shocks, without re-igniting inflationary pressures?
Core consumer price index (CPI)-based disinflation in the last few years reflected a rare confluence of domestic and external forces that are now reversing. Currently subdued core readings mask a likely uptrend with its own risks.
Real GDP growth averaged 7.3% between 2022-23 and 2025-26; it reached 7.7% in 2025-26, exceeding market estimates and likely outpacing India’s post-pandemic potential growth rate of around 7%.
Conventional economic models suggest sustained above-trend growth would tighten the output gap and lift inflation. Instead, India’s ‘refined’ core inflation, which excludes food, fuel and precious metals to better capture domestic demand conditions, fell almost continually from around 6% in early 2023 to 2.1% in the first quarter of 2026. Even after a recent pickup, it stood at only 2.5% in June.
The first piece of this puzzle lies in the composition of growth. Gross fixed capital formation (GFCF) has consistently outpaced private consumption, while the quality of investment has also improved. Government expenditure and real estate initially drove the post-pandemic investment cycle, but business investment has joined the trend.
Non-government real GFCF growth accelerated through 2025-26, industry capacity utilization has reached its highest level in nearly 14 years, large- industry credit growth has returned to pre-2013 rates and capital goods production growth has moved into double digits. The productive capacity of the economy has expanded faster than domestic demand.
A second factor is inflation expectations. Our research suggests that food prices, particularly those where price shocks persist, dominate household inflation expectations. Statistical tests identify wheat, pulses, edible oils, spices, beverages and packaged food as the key drivers of persistent food inflation. As these pressures eased after the post-pandemic surge, household inflation expectations declined. Lower expectations likely restrained wage pressures and pricing power across the economy.
The third explanation lies abroad. China has exported disinflation to much of the world. Excess industrial capacity, weak domestic demand and falling factory-gate prices pushed Chinese producer prices into deflation between late 2022 and early 2026. India has become increasingly exposed to this dynamic. Goods imports from China now exceed $130 billion annually, equivalent to around 3.5% of GDP.
The final factor is domestic policy. Broad GST reductions announced in late 2025 gave companies scope to cut prices. The refined core Consumer Price Index recorded a rare sequential decline in seasonally adjusted terms in October 2025, shortly after the GST cuts took effect. At the same time, consumption was softer than the headline growth suggested, and uneven. Vehicle sales remained firm, but several discretionary spending indicators weakened. Credit-card borrowing, consumer durable lending and broader discretionary spending all lost momentum.
All the four factors that explain refined core disinflation of the last few years are now perhaps turning. Consumption growth has improved and household credit growth has started accelerating.
Food inflation is again lifting inflation expectations, while China’s producer and export prices are reflating, aided by higher global commodity prices and supply-side pressures. The impact of GST cuts has faded. Rising input costs are pushing firms to rebuild margins through higher prices.
Recent inflation data underlines this shift. Refined core inflation stayed low in June but its sequential momentum strengthened materially; June recorded the fastest seasonally adjusted increase in 17 months. If that pace is sustained, refined core inflation could rise above 4% before the end of 2026 and further towards 5%, which would be unsettling.
Measures of inflation breadth have also widened, which suggests price increases are becoming more broad-based rather than concentrated in a handful of categories. These developments matter more for the medium-term outlook than the headline inflation rate itself.
This presents a policy challenge. The Reserve Bank of India has rightly focused on underlying inflation so far, rather than reacting mechanically to every move in food or energy prices.
There is still limited evidence of deeply entrenched inflation, while uncertainties around oil prices, global monetary policy and monsoon rains remain high. Heightened caution is warranted.
But policymakers should avoid drawing structural conclusions from an exceptional period. Weak core inflation was not evidence of a broken link between growth and inflation. It reflected an unusual alignment of domestic and external forces, most of which are now fading.
The inflation puzzle is getting easier to explain—and the risk is of underestimating the end of an era of effortless disinflation.
The author is an economist at ANZ Research.