India: Strong economy, but weak equity market

India’s current performance has been a bit mixed, while the latest gross domestic product (GDP) print has surprised on the upside and purchasing managers’ indices (PMIs) remain strong, equities have lagged, with MSCI India down about 9.5% year-to-date (YTD) in U.S. 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 versus global alternatives.

The most visible sign of investor unease has been heavy foreign selling, even as domestic participation remains strong. India has seen net foreign institutional investor/foreign portfolio investor outflows exceed a record USD 30billion YTD as of mid-June.

Macro strong, but still vulnerable 

On the macro front, India 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 from here, 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 can pressure the Indian rupee (INR) and, by extension, foreign investor appetite.

At the same time, global equity leadership has been dominated by artificial intelligence (AI) exceptionalism and the AI-and-hardware-driven boom, where India is not seen as a primary beneficiary and could be a victim instead, as its IT services sector could be rendered obsolete by AI. 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 fundamentals are supported by demographics, policy progress, and modernization.

Inflation is another factor continually looming unsettlingly over observers of India, and here weather risk is central. A 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 worryingly come in at about 40% below the long-term average. As it stands, the India Meteorological Department is expecting the current season to come in at about 90% of the long-term average. Compounding this, a strong El Niño effect is expected to disrupt rainfall patterns further, potentially making food inflation more persistent than markets would like. The issue is not only whether inflation breaches the upper 6% Reserve Bank of India (RBI) inflation target, but whether inflation becomes sticky enough to constrain policy flexibility at a time where higher energy prices are also threatening prices. Hopefully, a finalized peace deal in the U.S.-Iran conflict will reduce some of the risk here from the energy and trade side. 

The trade developments have seen some positives and should lead to better development of India’s manufacturing capabilities and higher investment. Landmark deals with the UK and the EU have been finalized and should be set for implementation this year. On the U.S. side, things are a bit more complicated. After a U.S. Supreme Court decision deeming certain unilateral emergency tariffs illegal (often referenced in connection with the International Emergency Economic Powers Act (IEEPA) or IEEPA-style authorities), the legal foundation underpinning the bilateral deal that was 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 in light of the new tariff regime from the U.S. means India loses some comparative advantage, but with things still in flux, a different agreement may still emerge. 

Significant policy action shows willingness to act

Against that backdrop, the 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 stabilize the rupee and improve the tone around capital inflows without resorting to rate hikes that could jeopardize 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.

Equity market dragged down by foreign caution

On the market itself, domestic interest and activity 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, as can be seen in Exhibit 1. 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. Rather than being a clear beneficiary of AI, India risks being a partial casualty of it, as the country’s large IT services industry could be vulnerable if AI reduces demand for traditional outsourced work.  When the global market is paying up for earnings streams linked to the AI investment cycle, markets without that direct linkage need stronger “own” earnings momentum to compete. India’s own earning per share (EPS) is still seeing growth, with the consensus estimate from FactSet at around 13% y/y for 2026, but it is not the kind of surprise profile that typically sustains premium valuations, particularly when global alternatives are seeing upgrades rather than downgrades.

The second reason is that 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 U.S. 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 itself 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 FX 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.

Investment implications

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.

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