From the CIO’s Desk – India Quarterly: Q1 2026

The first quarter of 2026 began with optimism, anchored by trade deals, a growth-oriented Budget, and easing inflation, only to be derailed by the escalation of conflict in the Middle East and the sharpest monthly foreign outflow on record. Yet beneath the noise, the structural case for India has arguably never been stronger. In this edition, we explain why we view the March dislocation as an opportunity rather than a warning and lay out four reasons why we believe Indian equities are entering a window of historically attractive forward returns. Enjoy!

Market Review

Indian equities continued to underperform regional peers in recent months, with the MSCI India Index declining 18.09% (in USD terms¹) in Q1 2026. What began as a quarter of genuine optimism, anchored by landmark trade agreements and a growth-oriented Union Budget, was derailed by the escalation of the US-Israel military operation against Iran, which became the dominant risk event shaping global markets from late February onwards. The resulting energy shock, rupee depreciation, and record foreign investor selling erased the nascent recovery and pushed Indian equities to fresh lows by quarter-end. Foreign Institutional Investors (FIIs) net sold USD 12.7 billion of Indian equities in March, the largest-ever monthly outflow on record, bringing Q1 2026 net outflows to approximately USD 14.2 billion.²

All sectors ended lower for the quarter, though Health Care and Materials were the relative outperformers, while Real Estate and IT were the worst-performing sectors. IT continued to face headwinds from a global sell-off driven by the “SaaSpocalypse” narrative, as investors reassessed software valuations in light of accelerating AI-driven disruption. Real Estate was pressured by rising bond yields, weaker sentiment around rate-sensitive sectors, and fading expectations for further monetary easing as oil-driven inflationary concerns mounted.

The quarter delivered several significant positive catalysts that, in isolation, would have supported a meaningful re-rating. The India-EU free trade agreement announced in January and the India-US interim trade agreement in February, which reduced tariffs on Indian exports from 50% to 18%, together de-risked India’s external trade outlook materially. The FY27 Union Budget, presented on February 1, reinforced the government’s fiscal discipline while raising public capital expenditure to INR 12.2 trillion (~USD 133 billion), a 9% increase over FY26, and narrowing the fiscal deficit target to 4.3% of GDP.³ The Reserve Bank of India (RBI) retained the repo rate at 5.25% at its February policy review, following a cumulative 125 basis points (bps) of rate cuts delivered over 2025, with headline inflation remaining well within the 2-6% tolerance band.

Domestic activity indicators remained resilient for much of the quarter but softened noticeably in March. Manufacturing purchasing managers’ index (PMI) rose to a four-month high of 56.9 in February before falling sharply to 53.9 in March, a 45-month low, as cost pressures, softer domestic demand, and heightened uncertainty weighed on factory activity.⁴ Services PMI eased to 57.5 in March from 58.1 in February but remained well in expansionary territory. This marked the weakest reading in 14 months, as the conflict disrupted international travel and dampened sentiment.⁵ Input cost inflation hit a 43-month high in March, driven by higher prices for commodities including aluminum, chemicals, and fuels. However, a notable bright spot was export orders, which surged to record levels as Indian manufacturers secured new business across Asia, Europe, and the US.

Headline consumer price index (CPI) inflation, reported under the newly rebased 2024 series, rose to 3.21% y/y in February (from 2.75% in January), remaining comfortably within the RBI’s tolerance band. However, the sharp rise in oil prices since late February may push inflation higher in the coming months.

Portfolio Commentary & Outlook

The ongoing conflict in the Middle East has triggered a sharp risk-off move across global markets. Asian equities have not been spared, dragged lower by the kind of “baby with the bathwater” correlations that have historically penalized emerging markets during global shocks. Foreign investors pulled an estimated ~USD 65 billion from Korea, Taiwan, and India in March alone, with India contributing the third-largest outflow in the region at -USD 12.7 billion.⁶

While the absence of a clear ceasefire remains a near-term dampener, negotiations are underway and making meaningful progress, validating our view that the March drawdown was a temporary dislocation. Markets appear to share this view – Asian equities rallied ~10% month-to-date as of April 13th, on the back of US-Iran negotiations, suggesting that the base case for a resolution is increasingly being priced in.

Our base case remains that the conflict will not escalate materially from here, and that it is in the interest of all parties to find an off-ramp. Negotiations have already made significant progress, and while the most difficult issues, particularly around Iran’s nuclear enrichment program, remain unresolved, neither side has shown an appetite for further escalation. We are optimistic that a middle ground will ultimately be found. China’s role will be critical in this regard; it is Beijing that has the leverage to bring Iran to the negotiating table, and we expect it to use that influence constructively. That said, we are not complacent. We are closely monitoring for signs of further escalation, and we acknowledge the tail risk that a prolonged US blockade of the Strait of Hormuz risks drawing China to the conflict in favor of Iran as they look to secure their energy supplies, which would meaningfully change the trajectory. For now, however, our central expectation is that all parties will seek a resolution in the near term, not least because the US has pressing reasons to move on.

Still, the market reaction overlooks a fundamental shift: Asian economies are more structurally resilient, less correlated to the conflict, and better positioned than in previous crises.

Before we turn to India specifically, two elements of the global backdrop are worth flagging as they directly reinforce the case for the region: the US political cycle and the evolving AI investment narrative. We cover both more in depth in our Asia Q1 2026 commentary, and summarize the key takeaways below.

1. The US Turns Inwards

The US is about to get preoccupied with domestic issues, and we believe markets are underestimating what that means for global capital allocation. The first half of any political term is the best window to tackle tough external challenges, and this administration has done exactly that: Iran, Venezuela, tariffs, immigration, and sanctions lists. The second half, heading into the midterms, will inevitably pivot toward the issues that drive electoral outcomes at home, namely affordability and job disruption. We expect US policymaking to become increasingly inward-looking and populist in tone, while the rest of the world, and Asia in particular, looks relatively more stable, predictable, and investor friendly by comparison.

The knock-on effect is a structural reallocation of global capital. The US represents approximately 30% of global GDP but nearly 60% of global market capitalization, an anomaly sustained by the perception of US exceptionalism and the dominance of US tech platforms. As US policymaking becomes more unpredictable and Asian policy frameworks continue to demonstrate stability and industrial focus, we expect that gap to narrow. This is not a short-term trade; it is a multi-year rebalancing that, in our view, has only just begun, and India is squarely in its path as one of the largest and most investable beneficiaries.

2. The LLM Disruption Thesis is Fading

Since September 2025, we have been making the case that the next leg of the AI story belongs to the adopters, not the enablers. The fear in the market has been that OpenAI and similar large language model (LLM) platforms would directly disrupt existing consumer internet businesses. Our view has consistently been the opposite: incumbents with distribution, data, and brand equity would be the real winners, and that view is now being validated. OpenAI’s consumer ambitions have repeatedly stalled, with pullbacks on Sora, the quiet dismantling of its Walmart tie-up, and limited traction on its commerce and travel portals. LLMs look increasingly commoditized, while smart incumbents are integrating AI to improve targeting, engagement, and unit economics. At the same time, hyperscaler capex has grown from approximately USD 250 billion in 2024 to roughly USD 650 billion in 2026, and is running into power constraints, political pushback, and a private credit market increasingly financing AI infrastructure that is itself showing late-cycle warning signs.

The AI jobs debate deserves particular attention for India, given the country’s unique exposure through its IT services sector. On the surface, India looks vulnerable: the IT services industry employs almost 6 million people, and a significant share of revenue comes from exactly the kind of code generation, testing, and back-office work that LLMs are now capable of automating.⁷ This concern has been a key driver of IT sector underperformance over the past year.

However, we believe the narrative has become too one-sided. Indian IT companies have navigated multiple technology transitions over the past three decades, from mainframe to client-server, to the internet, to cloud, and each time the obituaries were written prematurely. What ultimately matters is whether these businesses can reposition themselves from being suppliers of labor to being suppliers of outcomes, and the leading players are already moving in that direction by embedding AI into their delivery models and charging for productivity gains rather than headcount. Moreover, the more immediate job disruption is arguably occurring in developed markets, where companies are realizing that a developer in India armed with AI can more than match the output of a senior developer in the US.

Beyond IT services, India’s broader labor market is structurally different from that of the US. The bulk of Indian employment sits in agriculture, manufacturing, construction, and informal services, segments that are far less exposed to LLM-driven disruption than US white-collar work. If anything, AI adoption in India is more likely to act as a productivity multiplier for a young, digitally literate workforce than as a displacement threat. The political economy backdrop is therefore very different from what we expect to unfold in the US: where Washington will increasingly have to defend its middle class from AI, India can lean into AI as a growth enabler without the same political constraints.

3. Why India: The Dislocation is the Opportunity

Against this backdrop of a US turning inward and an AI cycle beginning to mature, India is uniquely well-positioned. The March sell-off has been indiscriminate, but with the Middle East conflict abating, the underlying case for India has arguably never been stronger. Below, we lay out four reasons why we believe the current dislocation is a compelling buying opportunity.

1. Valuations are now at their most attractive levels in years. MSCI India is trading at 21.9x 1-year forward earnings, meaningfully below its five-year average of 24.1x and one of the steepest discounts to its own history we have seen in recent years.⁸ Relative valuations are also at prior cycle bottoms, as indicated in the chart below. Importantly, the valuation reset has been broad-based rather than concentrated in a few pockets: the share of stocks trading below their 10-year average valuation has risen to 49%, the highest level in this cycle and up from just 15% at the September 2024 peak.⁹

   Chart: Relative P/B of MSCI India to MSCI Emerging Markets (EM) at prior cycle lows

   

   Source: Bloomberg, Morgan Stanley Research, April 2026

   Perhaps most compelling of all, the Nifty earnings yield to 10-year government bond yield spread has widened to approximately 191 basis points, a level at which Indian equities have historically delivered average returns of around 25% over the subsequent twelve months.¹⁰ For long-term investors, the setup is rare: India’s structural growth story remains intact, yet the entry price has reset to levels we have not seen since the early pandemic period, and the historical return distribution at current valuation spreads skews decisively to the upside.

   Chart: Nifty earnings yield vs 10Y Government spread currently at ~191bps; historically, implies ~25% average returns over the next 12 months

   

   Source: Bloomberg, Avendus Spark Research, March 2026
2. Fundamentals remain intact, and the near-term narrative is obscuring a genuinely constructive setup. The quarter delivered several meaningful positive catalysts that have been lost in the noise of the Middle East conflict, including the India-EU free trade agreement the India-US interim trade deal. Inflation remains comfortably within the RBI’s tolerance band and India’s FY27 growth outlook remains among the highest in the world despite near-term oil-related pressures. Consensus FY27 earnings for the Nifty have been cut by around 5% over the past twelve months, but the pace of downgrades has moderated meaningfully in recent months. None of the structural drivers that made us constructive on India heading into 2026 have changed, and the uniformly cautious consensus has, if anything, left the market significantly under-owned heading into a potential resolution of the conflict.
3. Activity on the ground is improving, and our channel checks reinforce the case. Despite the headline softening in March PMI readings driven by Middle East disruptions, domestic demand indicators remain resilient. Manufacturing new export orders surged to record levels in March as Indian manufacturers secured business across Asia, Europe, and the US, a direct validation of the China+1 thesis that has reignited following the recent trade agreements. The credit cycle is also gathering pace – adjusted for inflation, real bank credit growth has jumped from 6.4% in March 2025 to 12.2% in January 2026, effectively doubling, and the credit multiplier has risen to 1.7x from 1.2x in FY25, a signal of rebounding economic activity.¹¹ Listed corporate capex grew 9% y/y in the first half of FY26, with mid and small-ticket capex growing in double digits, and corporate commentary on the private capex pipeline is consistently constructive. Employment in both manufacturing and services continued to rise, with services hiring expanding at its quickest pace since mid-2025, and our conversations with portfolio companies point to a pickup in consumption, improving capex intentions, and steady credit growth. These are the kinds of grassroots signals that typically precede a market recovery.
4. India’s tolerance for oil shocks has structurally risen, and the market is mispricing this. The reflexive concern whenever oil spikes is that India, as a major crude importer, faces immediate pressure on the current account, inflation, the rupee, and corporate margins. But this framing is outdated. India’s tolerance threshold for crude oil has structurally risen to approximately USD 90 per barrel, meaningfully higher than in previous cycles, driven by a substantial expansion in services exports that now provide a durable offset to the oil import. Beyond this, India’s shock absorbers are among the strongest they have been in recent memory: system liquidity stands at INR 5.1 trillion (~USD 55 billion), foreign exchange reserves remain among the largest in the world at over USD 700 billion (providing ~11 months of import cover), and central government capex is running at 3.1% of GDP, supporting growth. India has also been systematically reducing its exposure to Strait of Hormuz transit routes over the past several years, with approximately 70% of crude imports now arriving via alternative routes, up from around 55% earlier.

   Chart: India’s tolerance threshold for crude oil price has been rising over the years, thanks to a low current account deficit (CAD)

   

   Source: RBI, Government of India, Avendus Spark Research, March 2026

4. Our Portfolio Positioning

We have been active, not passive, through this pullback. The sharp correction has created an unusually attractive opportunity set across our coverage universe, and we have been selectively adding to high-conviction names where valuations have overshot to the downside. Our portfolio remains anchored in the structural themes we have highlighted throughout the past year: consumer platforms and discretionary consumption, industrials and domestic manufacturing, financials, and healthcare.

• Consumer platforms and discretionary, where we are positioned for the urban demand recovery supported by GST rate rationalization, the structural deepening of organized retail and digital commerce, and the AI adoption story playing out within India’s leading consumer internet companies. As we continue to articulate, these are “last man standing” businesses with deep moats, proprietary data, and fulfilment and logistics infrastructure that cannot be easily replicated.
• Financials, particularly leading private sector banks, where the combination of accelerating credit growth, the transmission of cumulative RBI rate cuts, easing regulatory posture, and improving asset quality sets up a multi-quarter earnings recovery.
• Industrials and domestic manufacturing, where we continue to see robust government capex, an emerging private investment cycle, and India’s structural positioning as a credible China+1 alternative. Production-linked incentive schemes, the India-EU and India-US trade agreements, and the record export orders we are seeing in the March data all point to this thesis playing out.
• Healthcare, where we own companies that combine defensive characteristics with long-term structural growth from rising penetration, and where the leading operators are also among the most ambitious AI adopters in Asian healthcare. Apollo Hospitals, which we profiled in our January commentary, is a good illustration of how AI is being deployed not as a cost-cutting exercise but as a productivity multiplier for a structurally constrained healthcare workforce.

Our base case remains that the conflict will move toward resolution in the near term, driven by the strong economic incentives of multiple parties to de-escalate. Historical precedent shows that geopolitical oil shocks tend to create short-lived volatility, and markets typically look through the disruption once supply risks are quantified. When that inflection comes, we expect a rebound in Indian equities, and investors who are positioned ahead of it will benefit disproportionately.

Quarterly Conviction Calls

Each quarter, we highlight a select number of companies that showcase exceptional growth potential. These stocks on our conviction list represent opportunities we believe will deliver substantial value over the coming years. Here are the standout stocks we’re featuring this quarter.

As we have shared with many of our investors, the world today is going to be noisy, uncertain, and at times exhausting to navigate. Environments like this demand exceptional leaders, the kind who can see through the short-term fog and build businesses that compound for the coming years. A few extraordinary companies, run by a few extraordinary leaders, will rise above the rest through this environment. These are the companies that we look for, and it is also the kind of company that we strive to be.