India’s valuation reset has improved the opportunity, but patience remains warranted
India’s underperformance is largely explained by relative earnings and valuation dynamics versus AI beneficiaries. The valuation reset is real, but the catalyst for renewed relative performance is not yet obvious.
Authors
India has good trend growth within an emerging market context. It is a large economy with relatively favorable demographics and scope for productivity gains as growth in urbanization and formalization continues. It also has a record of relatively consistent corporate earnings delivery. But Indian valuations are typically expensive, and, at times, investors may consider that the valuation premium exceeds the growth premium. This will particularly be the case in periods when earnings growth and momentum are stronger in other emerging markets.
From standout performance to valuation compression
India outperformed strongly from 2021 through to the third quarter of 2024. Over that period, Indian earnings recovered strongly post-Covid, while valuations became increasingly expensive, supported by optimism around India’s medium-term growth trajectory and a significant increase in household equity participation. Meanwhile, Indian earnings outperformed those of the other three big emerging markets. Chinese earnings faced headwinds from the zero Covid policy and the downturn in real estate, while a downcycle in tech dragged on earnings in Taiwan and Korea.
Since then, Indian equities have lagged the broader emerging market complex. By the second half of 2024 valuations were rich versus their history, when elevated earnings expectations met moderating nominal growth, leading to negative earnings revisions. Secondly, equity issuance grew markedly as company owners took advantage of rich valuations, to levels that absorbed an increasing proportion of domestic equity inflows. On a relative basis, the tech cycle inflected and has since become supercharged by the scale of AI capex, driving strong earnings and revisions in Taiwan and Korea. More recently, the effective closure of the Strait of Hormuz has added to investor concerns given India's reliance on imported energy, particularly from the Gulf, and its exposure to higher energy prices.
Foreign investors have reduced exposure to India through time, and many are underweight India, as per Emerging Portfolio Fund Research data. A combination of a soft market and ongoing earnings growth has driven multiple compression.
Is now the time to consider lifting allocations to the market?
We think India still warrants a country underweight for EM investors. Why is this?
Are cheaper multiples sufficient to attract flow?
Valuations have improved in absolute terms and relative to broad emerging markets. However, while bank multiples look cheap versus their history, we believe banks lack near-term drivers. Non-bank multiples have eased but remain expensive versus history. This is not unusual. When investing in India, investors should be open to the idea that a valuation premium exists and will persist and that earnings momentum and relative strength can be a bigger driver of market outcome.
Is there a standalone case for India’s performance to improve?
One expected catalyst for 2026 was a reacceleration in nominal growth, supported by prior monetary easing and reduced fiscal drag, which was expected to support improving domestic demand. This catalyst has become less certain because of the disruption of shipping through the Strait of Hormuz. India is more exposed than other key emerging markets: India is a significant energy importer, while food and fuel are relatively big constituents in the Consumer Price Index (CPI) basket. While India has been moving to address issues of supply, higher energy prices impact terms of trade, currency, inflation, monetary policy and fiscal deficit. Any increase in food inflation may be aggravated by a potential El Niño weather event, which is historically associated with weaker monsoon rainfall.
A sustained resolution between the United States and Iran that restores normal shipping flows through the Strait would likely be supportive for market sentiment. However, we expect Indian inflation to remain elevated into 2027 and do not believe valuations are sufficiently attractive to justify increasing exposure on this factor alone.
What about the relative case?
A second and in our view more important near-term driver is the performance of tech hardware. Information Technology (IT) is a significant constituent in the MSCI Emerging Markets benchmark, with the dominant proportion being tech hardware, the “picks and shovels” of AI. At the time of this writing, IT accounts for a material share of the MSCI Emerging Markets benchmark following a period of significant outperformance. Due to very material growth in AI-related capex, companies in the tech supply chain have enjoyed a marked expansion in addressable market, with earnings and returns seeing further benefit from pricing power and operating leverage. IT has very strong earnings momentum.
We have top-down conviction that AI capex will remain strong in the near term: model capability continues to improve rapidly, commercial use cases for AI are proving up, inference is growing very strongly, and there is a deficit in compute. However, expectations and valuations at the stock level are increasingly elevated, which creates risk at some point from a slowdown in earnings momentum or negative revisions. It is very difficult to assess when this might be, but investors may increasingly look to rebalance from IT back into markets with different drivers. In that environment, India could attract foreign flow, from investors seeking longer-duration domestic growth exposure and steadier earnings characteristics. This is particularly true as India is a consensus underweight for foreign investors. We believe if market leadership transitions from IT, investors would only need to reduce the underweight on India for significant flow to return.
And is India’s structural case as good as it was?
The thesis for India’s structural growth remains intact albeit with one notable new risk: the extent to which AI might disrupt India’s service exports. India’s export share of GDP is relatively low in an emerging markets context, but the share of services within exports is high. Hence the economic implications of AI adoption may be more significant for India than for some manufacturing-led emerging markets. AI may not just disrupt IT services but business process outsourcing on a broad basis. The extent and breadth of disruption remain unproven, and India may adapt, as the capability and productivity of Indian workers and companies is enhanced by AI. But this is a risk that we will monitor carefully.
Conclusion
India's structural case remains attractive, and valuations are no longer as demanding as they were in late 2024. However, valuation compression alone is unlikely to be sufficient to drive a sustained improvement in relative performance. Near-term macro risks have increased, while earnings momentum remains considerably stronger in parts of the market exposed to the AI investment cycle. We continue to see India as a market with attractive long-term characteristics, but for now we believe patience remains warranted. A more constructive stance would likely require either a reacceleration in domestic earnings momentum, further valuation adjustment, or a decision that rebalancing away from AI-related tech exposure became warranted.
Authors
Tematy