What does the macro front show?

There has been mixed news on India.  On the good news front, India's growth prospects remain robust. The post-pandemic recovery has been solid, with real gross domestic product (GDP) expected to grow slightly below 7% annually over the next three years. With this, India would continue to be the fastest-growing major economy globally. The latest 2Q 2025 results were exceptionally strong at 7.8% year-over-year, mainly due to strong services growth and increased government spending. Overall, growth in India is underpinned by strong consumption and capital spending. Just like the U.S., consumption dominates the Indian economy, while manufacturing accounts for less than a fifth, and net exports even less.

India's fiscal management has seen continued significant improvement. Post-pandemic, the Indian government has been aggressively consolidating its fiscal deficit, exceeding targets due to higher-than-expected tax revenues. This momentum is anticipated to continue, with gross debt projected to decline from 82.9% to 79.9% by the fiscal year 2028. This fiscal management might be challenged by a surprise Goods and Services Tax (GST) reform announcement. This plan aims to simplify and overhaul India’s GST structure, reducing it from four main tiers to two tiers. What is essentially a tax cut could help boost demand in the form of increased spending, but it also raises the possibility of tax revenues falling short and undoing fiscal discipline efforts to keep the deficit under control. 

India's monetary policy remains stable. Unlike many major economies, the average past three-year inflation in India has stayed within the central bank's target range. Recent inflation prints have been at the lower end of the 2-6% band, providing more room for policy easing. A normal monsoon season should result in stable food production levels and mean food inflation issues won’t rear its ugly head.

The positive results and outlook on these factors of growth, fiscal position and monetary policy have caused S&P to upgrade India's sovereign rating to BBB, which should help support sentiment and provide lower borrowing costs for investment.

Tariffs a concern, but what’s the impact?

Then there is the bad news, which is India getting hit hard by U.S. tariffs. We have previously written that India would stand to benefit if they face lower tariffs than its major competitors, assuming the tariffs proceed as planned and announced by the U.S. Unfortunately, India has been hit with much higher rates than most.

The U.S. government’s 25% tariff on India came into effect on August 7, and another 25% kicked in on August 27. With the U.S. accounting for around 20% of India’s goods exports or slightly above 2% of GDP, the effective tariff rate would be at 35.2% by our calculations.

However, we should keep in mind that India is less trade sensitive, especially compared to some of the much more export-oriented economies in the region. After considering exempted sectors like pharmaceuticals, semiconductors, and electronics, exports to the U.S. represent only 1.2% of GDP, suggesting that the tariff impact may be relatively limited. Encouragingly, despite all the tariff headlines, the August PMIs climbed for both manufacturing and services, indicating that businesses remain optimistic. The bigger risk here is tariffs dampening sentiment and capital expenditure plans in India.

So, what about the equity market?

Despite a relatively better economic backdrop, Indian equities have struggled in the first eight months of 2025. The MSCI India Total Return Index is up just 2% year-to-date in local currency terms and down 1% in U.S. dollar terms. This marks a reversal after four years of outperformance, when Indian equities beat the broader emerging market (EM) index by a cumulative 67%. This year, however, they lag by nearly 21%, even as other EMs have gained from cyclical tailwinds such as currency appreciation and valuation rerating.

DXY weakness has not helped the Indian rupee

As the U.S. dollar index (DXY) has declined nearly 10% year-to-date, most EM countries have enjoyed a boost in USD-denominated returns. Brazil and Mexico, for instance, saw double-digit gains from currency strength. India, however, has not shared this tailwind. The Indian rupee (INR) has been one of the weakest EM currencies, down about 3% year-to-date, weighing on USD returns. One reason has been capital outflows: foreign portfolio investors have sold more than USD 15billion of Indian equities this year, cutting their share in the NSE-listed companies to around 17%, the lowest in roughly a decade and a half. 

With trade talks with the U.S. at a near standstill and the risk that the additional 25% tariffs may persist longer than initially anticipated, sentiment is unlikely to improve quickly. That said, the silver lining is that selling has not been indiscriminate: while information technology (IT) bore the brunt of outflows, sectors such as telecommunications and services have seen consistent inflows, highlighting how foreign investors are actively managing their exposure to India. At the same time, robust domestic participation has cushioned markets, preventing deeper declines.

Stretched valuations meet earnings downgrades

Indian equities have typically traded at rich valuations. Historically, this was not a concern as long as earnings growth kept surprising to the upside. Today, however, that dynamic has shifted. Valuations have eased only slightly, from 22.8x at the start of the year to 22.1x now, leaving them still about one standard deviation above the long-run average. At the same time, earnings expectations have been revised lower, with 2025 earnings per share (EPS) growth now projected at 11.6% (Exhibit 1), down three percentage points over the past six months. While the downward revision is consistent with other markets and double-digit growth remains respectable relative to other emerging markets, the combination of downward revisions to earnings and still-rich valuations has made investors cautious. Higher valuations have made India less attractive relative to other markets and adds to the potential for further EPS growth downgrades to lead to de-rating. Therefore, unless the earnings trajectory improves, caution among foreign investors is likely to persist.

Investment implications

Despite these headwinds, India’s structural growth story remains intact. India is still the fastest-growing major economy, and historically, its strong nominal growth has translated effectively into corporate earnings. Moreover, the fiscal and monetary policy backdrop is supportive. The recently announced indirect tax rationalization, together with direct tax cuts earlier this year, is aimed at spurring consumption and could act as a catalyst for earnings growth. While the central bank has already cut rates by 100 basis points this year, recent encouraging inflation prints suggest there may still be room for further easing. Alongside strong domestic participation, these policies provide a foundation for long-term value creation.

In the near term, though, performance will hinge on two factors: clear signs that earnings downgrades are bottoming out and tangible progress on trade uncertainty. Until then, investor sentiment may remain subdued. Against this backdrop, active management is critical, as sector-level divergences continue to create both risks and opportunities.

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