'Valuations already elevated, so large multiple expansion hard to justify'

Simultaneous fiscal and monetary tightening hurt growth and earnings, but momentum is returning, says Axis Bank's Neelkanth Mishra, signalling a possible market turnaround

Simultaneous fiscal and monetary tightening created a drag on the economy and markets, says Neelkanth Mishra, chief economist, Axis Bank and head of Global Research, Axis Capital. In an interview with Subrata Panda & Samie Modak, Mishra says as growth momentum becomes clearer, foreign investors, who went underweight India, may return. Edited excerpts:

 

Why did Indian equity markets underperform global peers this year?

 

FY25 saw simultaneous fiscal and monetary tightening. Fiscal tightening amounted to about 130 basis points — 80 explicit and 50 implicit — while credit growth slowed sharply, together creating a drag of nearly 2 percentage points of GDP (gross domestic product). This broke growth momentum and led to sustained earnings downgrades over 12 months. India was the worst-performing major market in terms of earnings revisions, which explains why equity indices largely stagnated rather than declined.

 

How did earnings downgrades affect market performance?

 

Typically, 12-month forward earnings trend upward due to roll-forward effects. Over the past year, however, earnings cuts offset these gains, flattening the earnings curve. With no earnings growth, markets also failed to move meaningfully. This phase now appears to be ending, which could mark a turning point for equities.

 

Why were foreign outflows particularly sharp?

 

India underperformed while most global markets rallied, causing its weight in global indices to fall. This amplified outflows, especially from passive funds. Additionally, India was perceived — incorrectly — as an “AI loser,” prompting some investors to underweight India and reallocate to AI beneficiaries such as China, Taiwan, and Korea. India also became a funding market for some investors during this phase.

 

What could trigger a reversal in foreign flows?

 

A recovery in earnings growth is key. India’s 12-month forward earnings are expected to grow by around 14 per cent in FY26 — among the strongest globally — which should lift index weights. As the narrative around AI becomes more balanced and growth momentum becomes clearer, investors who went underweight India may return.

 

How does the growth outlook for FY26 and beyond look?

 

Growth is reverting toward trend. We had forecast 7 per cent growth for FY26, based on the expectation that easing fiscal and monetary headwinds would restore momentum. Fiscal tightening is likely to reduce to around 20 basis points next year, while credit growth — having rebounded to about 12 per cent — should act as a tailwind. This supports a return to trend or slightly above-trend growth.

 

Can equity valuations expand from current levels?

 

Valuations are already elevated, so large multiple expansions are hard to justify. However, India’s valuation premium to global markets is at the lower end of its historical range. With estimated equity demand of about ₹7 trillion next year — potentially exceeding supply — even without FPI inflows, markets should remain constructive. If FPIs return alongside DIIs, valuation support could improve further.

 

Is India’s balance of payments (BoP) a concern, given the recent trade deficit and currency weakness?

 

Not really. While the October trade deficit raised concerns, the November numbers largely offset that. On a seasonally adjusted basis, the annual trade deficit works out to around $350 billion. With services exports generating a surplus of roughly $285 billion, the current account deficit (CAD) remains contained at about 1.5 per cent of GDP even with elevated gold imports. Given that the fourth quarter is seasonally weak, the full-year CAD should settle closer to 1.2-1.3 per cent, which is well within comfort levels. This is not a material BoP issue.

 

Then what is driving near-term pressure on the rupee?

 

The pressure is largely cyclical and flow-driven. In the short term, we are seeing FPI selling, global de-risking and a sharp rise in FDI repatriation. Strong equity markets have enabled strategic investors, MNCs, private equity and venture capital funds to exit at attractive valuations. As a result, annual FDI repatriation has risen from about $20-25 billion to nearly $45 billion, increasing short-term dependence on net FDI flows.

 

How should policymakers respond to the rupee’s movement?

 

The rupee should be allowed to find its own level. From a real effective exchange rate (REER) perspective, the currency is already near 10-year lows, which supports manufacturing and export competitiveness. Beyond a point, the Reserve Bank of India (RBI) will intervene to curb volatility — not to defend a specific level. With foreign exchange reserves at around $685 billion, there is no reason for concern. Importantly, the RBI should not be perceived as targeting a particular exchange rate level.

 

How does the global currency environment factor into this outlook?

 

We may be heading into a phase of competitive currency debasement. The US dollar is extremely strong and arguably unsustainable. Tariffs alone will not correct imbalances, raising the possibility of forced dollar devaluation. Unlike 1971 or 1985 — when adjustments were against the Deutsche Mark or yen — this time the adjustment may involve emerging market currencies, including China. In such an environment, having a slightly weaker currency is not necessarily a disadvantage.

 

What is the outlook for bond yields?

 

Given persistent economic slack — estimated at 5-11 per cent — inflation pressures are unlikely to return quickly. Rates could remain lower for longer. We expect the 10-year yield to decline toward 6.1 per cent over the next 12 months from about 6.6 per cent currently, assuming issuance strategy improves and market expectations adjust.

 

The Sensex has delivered about 15 per cent annual returns over 40 years. What explains this performance?

 

Over the long term, Indian nominal GDP has grown around 11-12 per cent, combining roughly 6-7 per cent real growth with about 4-5 per cent inflation, and corporate profits tend to grow at least in line with nominal GDP if their share in GDP is stable. On top of that, India has benefited from a secular decline in the cost of capital — with 10-year bond yields now around 6.5-6.6 per cent in non-crisis periods — and from a rerating of equity PE multiples as domestic and foreign participation deepened. Since FIIs entered the market, their ownership has risen from low single digits to the high teens, peaking above 20 per cent at various points, and they invest with a much lower cost of capital than local investors historically did. This structural shift, together with formalisation of the economy and more companies listing, has expanded the portion of national profits accessible via listed equities and supported higher market capitalisation and PE levels.

 

How has the sectoral mix of the Sensex evolved, and what comes next?

 

Historically, the Senex was dominated by industrials, energy and later financials, which became somewhat over-represented in market cap versus their share in the real economy due to their capital-market intensity. Over the next 5-10 years, the profit pool is expected to broaden significantly, with more listings in new-age, tech-enabled, services and niche manufacturing sectors.

Next: Navneet Munot, MD & CEO of HDFC Asset Management Company