Indian Markets in the Global Pecking Order

The rupee is wilting under weight of the ballooning trade deficit and the persistent pull out by FPIs which has exceeded Rs 80000 crores so far this year. FPI holding of Indian equities has come down from 20% in 2017 to about 17% now. However, consistent inflows into mutual funds (MFs) have been holding up the market. Will the FPIs return in 2026? The answer depends on, inter alia, on India’s position in the global investment pie.

As compared to 16% growth in Nifty earnings in 2024, that growth has decelerated to 6 to 7% in FY25 and first half of FY26, though the latest quarter has shown some uptick in earnings growth.

FPI investments follow earnings. As per Bloomberg, for the latest quarter, S&P 500 earnings growth is tracking 14%, y-o-y as against just 6 to 7% for Nifty. And India is still trading at 22 times its earnings against long term average of 17. Moreover, India does not account for a significant part of the global Indices. US’ market cap is 49% of the world market cap and its weight in the MSCI’s All Country World Index (ACWI) is 65%. In contrast, India’s market cap is roughly $5 trillion and is 4% of the global market cap. However, its weight in the ACWI is only 2%. But the entire FPI investment of about $820 billion in India is only 66 basis points (0.66%) of the world market cap.

Secondly, India is not on FPI radar because they are consumed by the excitement of the Tech (AI) rally and this fascination of theirs has been rewarded well in the last couple of years. And going forward, this excitement around AI seems justified. As Prof. Diganta Mukerjee of ISI, Kolkata observes, “AI is the next big thing after computerization. With computer applications we automated repetitive processes at the lower end of the value chain in the early 1990s. Now such replication is taking place at a higher level with AI taking over more complex yet essentially repetitive tasks such as decision making.”

It is another matter that AI math does not add up. The humongous investments that have gone into creating AI applications and related infrastructure like data centers will be remunerative only if the returns from tech companies undertaking such investments, like Meta, Microsoft, Open AI and Oracle touch almost $ 4 trillion and that is not going to happen in a hurry. Further, this mismatch in investments and earnings will be exacerbated by the accelerated pace of obsolescence caused by rapid change in chip design and manufacture. And sooner than later, given its massive and growing energy requirements, the AI ecosystem will have to reckon with consequent environmental challenges. So, before AI comes of age and AI investments mature, the mortality rate is bound to be pretty high in the AI battlefield, sinking many an associated investment.  

But the world is willing to be fooled and the frothy AI bubble may continue for some time to come. Although India is taking steps to attract investments in the semiconductor design and manufacturing, FPIs regard this initiative as too little, too late to be meaningfully competitive on a global platform. So, it appears that Indian markets will pick up only if US markets fall significantly. India, of course, has received part of the investments directed to the emerging markets, as it accounts for 17% of the EM Index. But even here, a significant part of such flow has gone into AI related plays such as semiconductor industry of Taiwan and Korea or the rare earths sector in China.

The patient and discerning investor, however, may find a silver lining in that while S&P 500, at present, being largely a momentum play, India offers a contrarian alternative. But stock picking is harder today in India, because one has to simultaneously assess and analyse both earnings and valuations. Expert view is that relatively cheaper valued names with earnings comparable to peers will do well across sectors. Consensus is that BFSI sector offers quite a few such names.