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India’s year-on-year (YoY) headline inflation rate, based on the All India CPI, stood at 1.55% in July 2025, according to a PIB press release on 12 August 2025. This marks the lowest YoY inflation rate since June 2017.

For a country like India, where a large segment of the population falls within low-income brackets, low inflation is a welcome development as it eases the cost of living. However, the decline in inflation has been driven largely by falling food prices—a significant shift considering that food inflation remained in double digits for several quarters until recently.

Food price inflation for July 2025 over July 2024 stood at -1.76%, the lowest since January 2019. Many observers have attributed this to effective economic management. Yet, several pressing challenges threaten the broader economic outlook.

Key Challenges Facing the Economy

Weak Direct Tax Collection : India’s net direct tax collections declined 3.95% YoY to ₹6.64 lakh crore between 1 April and 11 August 2025, as per Income Tax Department data. This decline, driven by high corporate tax refunds and delayed personal income tax filings, could pose a serious challenge unless the government achieves double-digit growth in tax collection over the remaining months of FY26.

Consumption and Investment Demand : Private Final Consumption Expenditure grew 7.2% in FY25, up from 5.6% in FY24, supported by rising rural demand. Favorable monsoon conditions, improved agricultural output, and higher rural spending fueled this growth. However, these factors may be temporary.

Weak Private Investment : Gross Fixed Capital Formation (GFCF) slowed to 7.1% in FY25 from 8.8% in FY24. In nominal terms, GFCF accounted for 29.9% of GDP, lower than the previous two years. RBI Governor Sanjoy Malhotra, in the latest MPC meeting, warned that geopolitical tensions and tariff uncertainties are dampening external demand and delaying private investment recovery.

Sluggish Auto and Housing Markets: Auto sector demand has remained weak across most segments, with domestic volumes (excluding tractors) falling 6% YoY in Q1 FY26. Rising input costs and uncertain export prospects have worsened the situation.

Housing sales in India’s top seven cities fell 20% YoY in Q2 FY25, with affordable housing (below ₹1 crore) witnessing the steepest decline, reflecting stress among lower and middle-income groups. In contrast, luxury housing (above ₹1 crore) continues to see strong demand—highlighting growing income inequality.

MSME and Export-Sector Distress : Ex-ternal MPC member Prof. Ram Singh noted signs of stress in MSMEs, particularly in export-oriented sectors like diamonds, jewellery, textiles, apparel, and fisheries, heavily reliant on the US market.

Likely Weak Bank Profits : A study by Kotak Institutional Equities projects weaker banking margins in Q2 FY26 due to RBI’s rate cuts making deposits less attractive, coupled with muted loan demand.

The Road Ahead

To sustain growth, India must strengthen its domestic economy. Greater focus on sub-district development, similar to China’s model—where over 75% of government development expenditure is directed at sub-district levels—could foster more balanced, grassroots-driven growth.

Targeted policy interventions to boost tax collection, investment, rural development, MSME competitiveness, and financial sector stability will be critical for ensuring long-term economic resilience.