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What bodes for India in FY26 is sure macro, stout markets, and a relatively less hostile world – So, expect returns to be still stout at 12-13% in FY26E after two years of outsized returns, especially for SMIDS (Nifty Midcap 150-24% and Nifty Small Cap 250-27.1% average through FY22 till date). We do not believe that India is in a structural slowdown – The turn in domestic monetary policy cycle, moderation in momentum of RBI’s monetary prudential tightening amid recovery in government spending and a less hostile world under Trump 2.0 will be positives for a cyclical recovery. We expect the equity markets to stabilize and passive FPI flows to return once USDINR finds a floor at 88-89. Also, expect macro-economic indicators for India to be sure as the country continues to be a positive investment case among EMs, aloft tailwinds – Stable fundamentals than peers, benefit of global supply chain diversification, limited impact of geopolitical shocks, muted global crude oil price, and likely softer USD from Q2CY25. Markets continue to trade close to peak valuation – Nifty at 19.6x forward P/E is only 9% below the recent 2024 peak. But absent any abrupt negative trigger, valuation may not correct too sharply

India – Cyclical factors to turn gradually supportive: The biggest factor stabilizing the equity market hereon will be the turn of monetary policy cycle and peaking macroprudential tightening momentum. The RBI’s willingness to allow the Rupee to depreciate in line with REER under its new Governor Malhotra and readiness to provide liquidity to the banking system strongly indicate a shift in its monetary stance. A cursory look at the list of macroprudential decisions by the RBI in the past few days in CY25 suggests that the momentum of supervisory actions has peaked. The Indian economy is amid resumed government spending that had given way on election-led pause.

India – Passive FPI outflows to bottom as USDINR touches 88-89: Per historical analysis of trough-peak cycles for USDINR and overall FPI flows, the median troughto-peak (depreciation) move in USDINR in the past decade in the pair has been at ~6.6% (averaging ~7.9%; minimum 8.4%). Per our analysis of the cycles, the USDINR may trough at 88-89 by Q1FY26E, before passive flows start to reverse. Per data from EPFR, ‘India dedicated long only fund’ flows saw positive inflow in December 2024 even as India dedicated ETFs have seen a constant outflow since October 2024, coinciding with a time when the markets began to price in a Trump victory.

Trump 2.0 – More peace than war: In our high conviction contrarian call, Trump 2.0 may be less hostile to China than Trump 1.0. Any extreme tariff or hardline immigration policy enactment may be inflationary in an economy that is at full equilibrium. We project Core PCE-based inflation at 2.5% (Q4/Q4) in CY25E versus 2.8% CY24E (Q4/Q4). We see DXY Index (USD) nearing its peak and expect it to begin moderating in a sustained fashion from Q2CY25, as stronger USD impacts US corporates, offsets tariff impacts, US fiscal stress magnifies, a more conciliatory China ups the odds of negotiations with the US, the Fed stays on rate cut path (Elara Estimates: 50bps), albeit at a moderate pace, and the Bank of Japan (BOJ) hikes rates.

Themes for FY26: While we do not rule out near-term volatility, we are not in the camp that believes that the Indian economy is in structural slowdown. We see the recent slowdown as cyclical and expect a gradual uptick as the year progresses. We stay Overweight on IT and Pharma, near-term and prefer the government capex theme over consumption medium-term. We prefer Banks (cheap valuation/ low asset quality risk) and Power (fair valuation after correction). We favor Cement (near-term pick-up in government capex) and select Defence and Capital Goods plays. For global asset classes, selective risk-on may trump risk-off. In bonds, prefer UST short end and IGB 10y in EMs. In commodities, pick gold, rare earths, aluminium, and copper.

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