India’s economy has grown faster than expected, with the latest GDP data surprising on the upside, while purchasing managers’ indices (PMIs) remain strong. However, equities have lagged: the MSCI India is down about 9.5% year-to-date (YTD*) in US dollar terms. The disconnect is a reminder that “good macro” does not automatically mean “good stocks,” since returns also reflect starting valuations, currency moves, earnings momentum and relative appeal vs. global alternatives.
The most visible sign of investor unease has been heavy foreign selling, even as domestic participation remains strong. Net foreign institutional investor/foreign portfolio investor outflows exceeded a record USD 30 billion YTD* as of mid-June.
Macro strong, but still vulnerable
India’s economy has proven surprisingly robust. 1Q 2026 real GDP growth surprised on the upside at 7.8% year-over-year (y/y). However, expectations are for growth to cool, which matters for forward-looking equity markets. India is also viewed as relatively more exposed to external shocks at an awkward moment. The conflict in the Middle East could disproportionately affect India through energy and shipping disruptions that worsen the trade balance and raise inflation risks, both of which could pressure the Indian rupee (INR) and, by extension, foreign investor appetite.
At the same time, global equity leadership has been dominated by companies and economies related to the buildout of artificial intelligence (AI). India is not seen as a primary beneficiary of this trend and its information technology (IT) services sector could be negatively impacted by AI instead. When markets are rewarding semiconductor-heavy and AI infrastructure ecosystems, markets without clear “hardware AI leverage” can be left behind in relative performance, even if domestic economies are supported by demographics, policy progress, and modernization.
Inflation is another risk factor for India, and weather risk is central. The weak start to the monsoon raises concerns because India’s food supply and, therefore, food inflation still depends heavily on rainfall distribution. Monsoon season stretches from June to September, and the June numbers have come in about 40% below the long-term average, although the India Meteorological Department is expecting the current season to come in at about 90% of the long-term average. A strong El Niño effect is expected to disrupt rainfall patterns further and potentially make food inflation more persistent. The key issues are whether inflation breaches the upper 6% Reserve Bank of India (RBI) inflation target and whether inflation becomes sticky enough to constrain policy flexibility at a time where higher energy prices are also threatening prices. A finalised peace deal in the U.S.-Iran conflict could reduce some of the risk from the energy and trade side.
Trade agreements should lead to better development of India’s manufacturing capabilities and higher investment. Landmark deals with the UK and the European Union (EU) have been finalised and should be set for implementation this year. On the US side, things are a bit more complicated. The US Supreme Court decision deemed certain unilateral emergency tariffs illegal, meaning the legal foundation underpinning the bilateral deal hammered out in early 2026 is now in doubt and may now be unfavorable for India, as it was negotiated around the original higher tariff regime. Implementing that trade deal under the new US tariff regime means India loses some comparative advantage, but a different agreement may still emerge.
Significant policy action shows willingness to act
Against that backdrop, the Reserve Bank of India (RBI) has turned slightly more cautious on the macro outlook. Growth forecasts for 2026–2027 were revised down to 6.6% y/y (from 6.9%), while inflation forecasts were shifted up to 5.1% y/y (from 4.6%). Those numbers still imply a healthy growth rate in absolute terms, but the direction of revisions matters. Softer growth plus higher inflation is a less comfortable combination, particularly when markets are already worried about valuations and currency.
In support of the currency, which has been one of the weaker-performing regional currencies this year, policymakers have rolled out measures to stabilise the rupee and improve the tone around capital inflows without resorting to rate hikes that could jeopardise growth. In trade-weighted real effective exchange rate terms, the rupee is down more than 6% YTD*. The intent is clear: officials are trying to prevent currency weakness from becoming self-reinforcing via portfolio outflows by improving incentives for foreign currency inflows and broadening the investor base.
Domestic equity market support meets foreign caution
Domestic interest and activity in the Indian equity market are still strong and likely the reason why valuations have not de-rated significantly. The underperformance appears to be primarily driven by foreign investors selling out of Indian equities and rotating into other emerging markets such as Korea and Taiwan that are more levered to the AI cycle. We believe there are two main forces explaining why investors are so cautious. The first is that India’s relative earnings momentum has disappointed. While India’s structural story remains intact, the market has had to digest repeated downward revisions. At the same time, markets like Korea and Taiwan enjoyed upgrades because they sit much closer to the center of hyperscaler capex and the AI supply chain.
The second reason is that Indian Rupee (INR) depreciation has accelerated in a way that materially undermines USD-based returns. Over the two decades through 2024, INR depreciation averaged roughly 3.2% per year, but that pace moved closer to around 5% in 2025 and has been roughly 5% again so far this year. For foreign investors, that is not a small swing; it can be the difference between a market that “works” in US dollars and one that persistently disappoints. Unsurprisingly, as relative returns and the currency backdrop have deteriorated, India’s weight in MSCI EM has almost halved from a peak of around 21% in 2024 to only around 11%-12% as of mid-2026, which can reinforce outflows through benchmark-driven reallocation.
So where do we see possible improvements and turnarounds? In the near term, support for the INR is focused on attracting foreign currency inflows and easing foreign participation—such as boosting Non-Resident Indian dollar deposits and encouraging demand for government bonds—which can reduce the risk of disorderly currency moves and help foreign investors re-engage. Longer term, trade and investment channels look more constructive: trade deals could lift foreign direct investment initially and strengthen exports and the current account over time, improving both macro stability and the equity market’s appeal to patient foreign capital.
Indian equities may provide AI diversification
When global equity returns are being driven by a single, dominant theme like AI, the risk for investors is that portfolios become unintentionally concentrated in one trade at exactly the wrong time. India may be one way to maintain diversification. Its limited direct exposure to the AI hardware cycle has held back relative performance during this rally, but it also means India has tended to show a lower beta to the AI trade. If the market leadership narrows further, or if concerns emerge about the sustainability of AI-related earnings expectations or capex intensity, India could offer an investment with lower correlation. For investors, that potential diversification benefit is particularly relevant as some of India’s recent headwinds appear to be easing, creating scope for returns to improve even without India needing to jump on the AI bandwagon.