Flawed to say domestic flows alone inflate India's valuations: Ridham Desai

The domestic markets have traded at a premium to emerging market (EM) peers long before the domestic investment boom, says Ridham Desai, managing director and chief India equity strategist, Morgan Stanley India. In an interview with Samie Modak and Sundar Sethuraman in Mumbai ahead of Morgan Stanley’s annual India Investment Forum, Desai said sustained foreign portfolio investor (FPI) flows will depend on India maintaining its appeal as a stable and high-return market. Edited excerpts:

 

What has driven the Indian stock market’s sharp rebound from the April lows? 

The market’s recovery can be assigned to three factors.

 

First, the Reserve Bank of India (RBI) pivoted its monetary policy in February 2025, offsetting the government’s sharp fiscal consolidation, which had slowed the economy.

 

Second, stocks — particularly in the broader market — became attractively priced, triggering sizeable domestic buying in February and March, even as foreign investors sold off.

 

Third, India’s relative stability in a world shaken by US policy changes, such as Trump’s tariffs, made it a standout.

 

Why have FPI flows remained soft? 

India’s market is now heavily driven by domestic investors, a trend that began in 2015 and could last for decades. Domestic investors, including institutions and retail, are secular buyers. This leaves little room for foreign investors to buy unless they bid up prices, which we’ve seen when foreign buying pushes the market higher.

 

While other EMs may offer cheaper valuations, India’s premium is justified by its superior return on capital and diversified, less volatile earnings growth. However, foreign inflows are crucial for macro stability due to dollar inflows. Sustained FPI flows will depend on increased corporate issuance and India maintaining its appeal as a stable and high-return market. 

 

Some argue that India’s high valuations are driven by domestic flows. How do you respond? 

The narrative that domestic flows alone inflate India’s valuations is flawed. India has traded at a premium to EMs since 2002–2003, long before the domestic flow surge began in 2015. This premium stems from Indian companies’ focus on balance sheet strength and consistently higher return on capital compared to peers like China.

 

India’s diversified market delivers stable, compounding earnings growth, unlike the cyclical nature of other EMs. The systematic investment plan boom has amplified this trend, but it’s not the sole driver. India’s structural strengths justify its valuations.

 

How does US trade uncertainty impact the earnings per share of Nifty companies? 

US-India trade constitutes only about 2 per cent of India’s gross domestic product (GDP). A swift trade agreement with the US is likely, limiting direct exposure. However, slower global growth, driven by US trade policies, will indirectly affect India, as 20 per cent of its GDP relies on global engagement. While we do not foresee a US recession, global growth is expected to decelerate, prompting us to revise India’s earnings estimates downward from earlier, more optimistic projections.

 

Which sectors will face deeper earnings cuts, and which will remain resilient? 

Domestic-focused sectors such as financials, consumer discretionary, and industrial goods are expected to be more resilient. In contrast, globally exposed sectors like software services, energy, and materials (excluding cement, a domestic sector) are likely to face deeper earnings cuts. We expect earnings growth of 14–15 per cent over the next 12 months. Our portfolio stance is overweight in financials, consumer discretionary, and industrials; underweight in energy and materials; and neutral on software services, where much of the price correction has already occurred.

 

What are the key headwinds and tailwinds to watch? 

The headwinds are US trade policy uncertainty, a US demand slowdown, and weakening global growth. Potential tailwinds are the RBI’s dovish policy, fiscal flexibility, and India’s relative strength. The sharp fall in oil prices is positive, but oil’s impact on India’s economy has significantly diminished. Even if oil prices rise to $100 a barrel, the impact would be manageable. A $20–30 price increase may cause short-term pain but is unlikely to derail India’s economy, unlike in 1991 or 2008.