Why India is well placed for recovery after a bruising 2025

Indian equities had a challenging 2025, with the MSCI India Index returning 3% in US dollar terms versus the broader emerging market region’s gain of 30.6%. This underperformance was one of the widest relative gaps in several years. While India continues to be among the fastest-growing economies globally, its GDP growth has moderated from 8-9% to around 7%.

More importantly, India saw a material slowdown in earnings growth last year, which impacted sentiment significantly. The slowdown was driven by margin pressure on rising costs, delayed private sector capital expenditure, and global headwinds including trade and tariff risks.

This was exacerbated by a global rotation towards AI-exposed markets. India, with its limited direct AI exposure, was left on the wrong side of the rotation. Foreign outflows spiked as a result, albeit this was offset by solid domestic buying.

Now well into 2026, the long‑term growth story remains intact, and the near‑term picture is improving. The earnings downgrade cycle appears to have bottomed as macro conditions turn more supportive. Valuations have reset meaningfully, with India’s premium over other EM peers at decade lows, while relative performance has lagged peers by the widest margin in decades. With earnings momentum poised to recover, the set‑up looks increasingly constructive over the medium term.

Macro and policy uncertainty has eased meaningfully

Firstly, the most visible improvement is on trade. Recent trade deals with the United States and the European Union have reduced uncertainty around tariffs and market access, a big overhang in 2025.

Moreover, the Reserve Bank of India (RBI) has likely concluded its rate-cutting cycle, holding its policy rate at 5.25% in February and shifting its focus towards ensuring adequate liquidity and effective transmission. This is supported by benign inflation and strong external buffers. Foreign exchange reserves stand at around US$709.4 billion as of 23 January, providing comfortable import cover and room for the RBI to manage currency volatility if needed.

Fiscal policy has also been steady. The recent Union Budget was broadly neutral for equities, government capex continuing to grow broadly in line with nominal GDP.

Earnings downgrades appear to have reached a trough

There are signs that conditions are stabilising on the corporate front. The recent reporting season broadly met expectations, with fewer negative results surprises sector-wide. Across our holdings, aggregate operating margins have improved, return on equity remains robust and leverage is low. Earnings growth momentum remains strong.

More broadly, there is improvement in activity. Manufacturing output rose 8.1% year-on-year in December 2025, while overall industrial production increased 7.8%, the strongest reading since late 2023.

As for consumption, with middle class relief delivered last year, demand remains uneven. The rural-urban demand gap persists, although Goods and Services Tax (GST) normalisation pre-Budget should help in narrowing the divide as GST collections continue to grow.

That said, the private capital expenditure cycle remains tentative. While pockets of improvement are evident, corporate investment intentions remain cautious, and it would be premature to characterise this as a broad-based private capex recovery.  We would expect an earnings recovery to be more likely led by a stabilising domestic cycle and benefits from public capex, rather than a sharp rise in private investment.

Valuations and flows primed for reset opportunity

After last year’s underperformance, Indian equities have de-rated relative to their own history, and their valuation premium versus both EM and Asia has narrowed meaningfully to more reasonable levels.

Investor flows reflect this reset. Foreign investors sold US$18.8 billion in 2025, the largest annual outflow on record, while domestic investors provided a stabilising offset with record inflows of around US$90.3 billion.

With China having rebounding strongly and AI-related trades now more crowded, relative opportunities across EM are becoming more balanced. In this context, India’s combination of more reasonable relative valuations, stabilising earnings and improving macro visibility has become increasingly more attractive for investors.

How all this benefits the Trust

The Trust remains a portfolio of high-quality stocks. It is well positioned to benefit from improving earnings conditions while maintaining a disciplined approach to risk management. Currency exposure is actively monitored, and internal stress testing indicates resilience even under a scenario of a sharp depreciation of the Indian rupee. We limit exposure to companies with significant foreign-currency debt or heavy import reliance, and instead favours businesses with solid balance sheets, domestic revenue visibility and the ability to compound earnings through economic cycles.

Conclusion

While it is hard to call the exact timing of a sustained recovery, the combination of easing uncertainty, stabilising earnings and more reasonable valuations suggests that the current environment is increasingly supportive for investors looking at India.

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. The company is authorised and regulated by the Financial Conduct Authority in the UK.

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