Are Indian Equities Getting Their Mojo Back?

Foreign investors are making a voyage of rediscovery of India. Their tentative return since June has expanded in July so far from debt to equities, after months of persistent stampeding out of Indian assets. In fact, equities have drawn the bulk of inflows in July, in contrast to June, when debt became attractive after access to sovereign debt was expanded and favourable tax treatment was offered. 

What could be inspiring the reversal? The flight that preceded it was attributed to the absence of an AI theme in Indian equities, overvaluation, global uncertainties, and India’s vulnerability to crude oil supply disruptions and price surges.

What has changed? Perhaps a little of each?

Let’s take global developments first to set the ball rolling. There are tectonic shifts still underway in the global macroeconomic and financial environment, and geopolitical anxiety remains the main driving force. Warring parties are jettisoning the script about how to end wars just as the light at the end of the tunnel comes into sight.

Taking a leaf out of that famous movie about Las Vegas, what happens in West Asia never stays in West Asia. These developments have ramifications for global financial markets, supply chains, and the global economy at large.

Despite the planned reopening of the Strait of Hormuz suffering setbacks in the form of frequent closures as warring parties lose their way to detente, the risk of a severe global downturn is fading.

Crude oil prices have retreated from war highs, and spikes that have intermittently followed are nowhere as sharp as when hostilities began. Supplies are returning to pre-war levels, boosted by inventory drawdowns and diversification of supply sources. 

India has been a frontrunner in this ‘just-in-case’ response, with the recent emphasis on ethanol blending representing another insurance strategy even as its dark side is being debated. Although it could take months for disruptions of the Hormuz squeeze to unwind, the world has pulled through. Global economic prospects are only a little dented, not devastated, by this geopolitical strife.

This is a clear positive for India, especially because of the manner in which it has handled the crisis. Its strategy is best reflected in the revision in the composition of the Indian basket of crude. India flipped its official crude pricing basket after the West Asia/Iran conflict disrupted regional oil supplies. Brent-linked sweet crude now dominates at 79.40%, while Dubai-Oman sour crude has been slashed to 20.60%. Before the conflict, Dubai-Oman sour crude made up the dominant share, with West Asia supplying 60-70% of total imports.

What should not be trivialised, however, is the redux of inflation on the back of elevated input costs. Accordingly, as threats to inflation targets have intensified, central banks have begun raising policy rates, with at least 10 emerging market economies leading the way. Others have announced hawkish pauses. The few that have cut rates have warned that geopolitical tensions could worsen inflation.

This time around, central banks will not back down. They clearly do not want to be blindsided as they were in 2022. Again, a positive for equities in general: as interest rates rise, equity prices will soften, creating attractive entry points for investors as central banks regain policy credibility by containing inflation expectations.

Turning to financial markets, global equity markets suffered pullbacks at the beginning of June amidst concerns over the overvaluation of tech stocks. Markets recovered in mid-June after the US-Iran peace deal announcement and stronger-than-expected first-quarter corporate earnings.

However, major equity indices slipped with the hawkish Fed statement. In July, equity markets are navigating geopolitical volatility again, following the reinstatement of the Strait of Hormuz blockade. In Asia, equity prices are facing headwinds from AI and semiconductor volatility as questions regarding heavy capital expenditure become louder as April-June quarter earnings kick off.

Global bond markets are seeing yields hit multi-decade highs amidst renewed geopolitical tensions and surging borrowing costs, after remaining range-bound through June on easing geopolitical tensions and moderating energy prices. The emerging market bond yield spread has narrowed, reflecting the tempering of risk perceptions in response to the resilience of these economies. The US dollar strengthened on the Fed’s hawkish stance and safe-haven demand.

To sum up, investors are looking towards rotating allocations again. If the flows of July are any forward indication, India may just be emerging as the flavour of the season.

As mentioned earlier, India has managed the Strait of Hormuz impasse relatively well and shown unexpected resilience in the context of the geopolitical situation, despite its energy vulnerability.

The Principal Secretary to the PM, Shaktikanta Das, has indicated in a conversation with the Financial Times that 8% growth is within striking distance, following up on 7.8% clocked in January-March 2026, which is the latest available data. Inflation has ticked a little above target; although producer prices and inflation forecasts point to upside pressures, the inflation targeting framework will work like a recoil, having stood the test of geopolitical adversities.

Domestic financial markets appear decoupled from the global situation. Money market rates eased in June with the infusion of liquidity by the RBI. G-sec yields have softened after the government and the RBI took measures to attract foreign capital. Corporate bond yields have moderated across tenors and rating spectrums, tracking government bond yields, while spreads have edged up.

Bank credit is sustaining double-digit growth across major sectors, especially industry. Equity markets recorded declines in early June amidst uncertainty surrounding the US-Iran peace agreement, elevated crude oil prices, and the forecast of a below-normal monsoon. Markets recovered in mid-June on optimism around the US-Iran peace talks and moderation in crude oil prices.

As the month concluded, benchmarks faced selling pressure due to monthly F&O expiry and renewed US-Iran tensions. In July, high volatility has returned, with markets swinging between record highs and steep corrections, driven by the West Asia situation, the flux in global crude prices and upcoming corporate earnings.

Against this backdrop, two questions come to mind.

First, over the last three years, Indian equities have underperformed vis-à-vis emerging markets, bucking the longer-term trend, largely due to Korea and Taiwan, which are driving the AI boom. As a consequence, India’s forward earnings growth performance has been completely overshadowed by these two countries. But what if AI is a bubble, like the dotcom episode?  We saw a play of such a situation on June 23 when a tech stock sell-off spread across Asia. Korea’s Kospi fell almost 10%, triggering a 20-minute trading halt once circuit breakers hit. Japan’s Nikkei, Taiwan’s index and China’s Shanghai Composite and even the Nasdaq declined, but India was relatively insulated. The Sensex fell 1% but recovered to close the week a little above where it started.

Does India offer resilience, with its measured exposure to AI in new investments but a wider diffusion, reportedly in the third position in the world in terms of AI competitiveness? India’s case would rest not merely on being relatively insulated from a likely AI correction, but on its capacity to capture productivity gains as AI diffuses across banking, services, healthcare, industry, and the wider economy.

India’s attractiveness is also supported by historically less volatile earnings growth and, more recently, a more favourable positioning on corrected valuations.  

Second, the exchange rate of the rupee and Indian equity prices tend to co-move closely both during periods of stress and in times of peace. In times of stress, both feed on each other, but up to a point, when valuations correct enough to start a virtuous cycle again. In past episodes – 2008 (GFC); 2013 (taper tantrum); 2018 (ILFS); 2020 (pandemic) – it has been policy intervention that has been the circuit breaker.

Today, both these factors are at work. One, India's valuation premium has fallen close to the long-term trend. It has also corrected relative to emerging markets. The rupee has depreciated in real terms. Two, the policy response to support the rupee has kicked in. Are these forces conspiring to bless a resurgence of investor interest in Indian equities, with the exchange rate correction reinforcing it?

The answer will ultimately lie not in one month’s aggregate flows, but in their enduring and gaining sectoral breadth, accompanying earnings revisions and the returns foreign investors realise after allowing for the exchange rate.

In numerology, the number 7 is associated with divine completion, reflection, and restoration, making July a designated period to pause and realign.