Why “No” is a default answer

Continuing from the previous week (Just like that)

Have you noticed that whenever you ask your child to break a routine, e.g., wake up early, sleep on time, eat healthy, spend less time on the phone; the default response is mostly “no”! You try to offer incentives or sometimes use threats to elicit compliance, which in most cases is not a durable response.

Try remembering your childhood – didn’t you also behave in the same manner with your parents, as your child is doing with you?

Now recall the response of the government officer, customer care executive, your senior in the office, your housemaid, your car mechanic, et. al. whenever you made a request that was not routine or strictly as per the laid down procedure. Wasn’t the default answer mostly “no”.

In my view, the default “no” is deeply ingrained in our social and cultural consciousness. This could be one of the root causes of several problems afflicting our society. We as a society are not adequately trained to manage exceptions. It is one of the major causes of widespread corruption, avoidable litigation, and mafia.

What a “no” costs

A flat “no” for a small deviation that could have been ignored or corrected leaves you with three choices. You can pay the officer, hire a middleman, or go to court. Say a minor defect in your papers means two more rounds of a government office. Paying Rs 2,000 to get it done today looks cheaper than two lost days, and many of us pay. The work gets done, but the citizen has paid extra in money, effort and time.

The worst damage is slower. You stop trusting the system. Middlemen find a steady business. Bribery starts to look normal, and in the worst cases, the mafia fills the gap.

Why the officer says “no”

Since last week’s post, I have been thinking about why the officer says no so quickly. Part of it is habit. But I think a large part is plain safety. If he says no, nobody can question him. If he says yes to an exception and something goes wrong later, he alone has to answer for it, maybe years later, in an audit or an inquiry.

This is the same thing I wrote about last week: adding a check is safe, and removing one is risky. The officer is not stupid or lazy. He is doing the sensible thing for himself. So, I would not blame culture alone. Culture teaches the habit, and the incentive keeps it going.

Why a simple fix will not do

My answer was simple: review the procedures, build rules for exceptions into them, and train officers to say “this can be done this way” instead of “this cannot be done”. I still believe in it, but there is a catch. If every exception depends on one officer’s judgment, we have only given him more power, and more power at the counter is exactly where bribes come from.

So, exceptions need a written route. A short list of small defects that can be corrected at the counter, such as a missing stamp or a spelling mismatch. A fixed time limit. A record of what was allowed and why. And a senior who must decide within a few days if the officer cannot. With this, the officer is covered when he says yes, and the citizen has a way forward when he hears no.

Teaching children to handle a break from routine is a good idea too. It will take a generation to show results, so it cannot be our only answer, but it costs very little to begin.

What this means for an investor

You can carry the same thought into investing, but I need to be careful here. When you read the management commentary of your companies, you will often find lines like these:

·         The execution of the project was delayed because it rained heavily during the monsoon.

·         Pollution control measures in Delhi NCR impacted the execution of projects.

·         We could not meet margin guidance due to raw material inflation.

·         Forex loss affected the reported profit by 10%.

·         Shortage of raw material due to the war in the Gulf region impacted production materially.

·         Competition from cheap Chinese imports is hurting margins.

When I first read these, I called them excuses. That is too harsh, because some are fair reasons. What matters is which kind of reason it is.

Some of them are predictable. The monsoon comes every year. Pollution curbs in Delhi NCR have been a regular feature of recent winters. Raw material prices go up and down, and currencies move. A company that is caught out by these again and again has not planned well. A forex loss that cuts profit by 10% suggests a large exposure was left open. It may have been a choice, because hedging costs money, but as an investor you should know it was a choice.

Others are not predictable. A war that cuts raw material supply is not something anyone can plan for in detail. Here the test is not whether the shock came, but how the company responded. Did it find another supplier, pass on the cost, or just wait? Competition from cheap Chinese imports is a different matter again. It is not an exception at all. It is a question about the company’s cost position and pricing power, and it depends on your view on the quality of the business.

So, I would not cut a company’s valuation just because its commentary has a reason in it. I would ask a few questions first:

·         Does the same reason come up quarter after quarter?

·         Did peers face the same problem and do better? If they did, the reason is not the whole story.

·         Has management met its own guidance in the past, or does it keep missing?

·         Does the company hold buffers, such as cash, hedges or alternative suppliers, for risks it knows will come back?

If the answers are poor, I would want a bigger margin of safety before I buy. I do not have a formula for it, and I would be wary of anyone who says they do.

A good system says “no” when it must, and “yes, if” when it can. I would look for the same habit in a good management. I would also like to hear your own experience of the default “no”, from either side of the counter.

 

Expect the unexpected

In the past couple of months, I happened to discuss the market situation with several market participants, including investors, advisors, distributors, brokers and portfolio managers.

Three sentiments were common to all of them. First, the pain of losses. Second, disappointment that Indian equities have underperformed despite resilient GDP growth and decent corporate earnings. Third, anxiety over the trend in bond yields and precious metals prices. Most of them blamed the government’s taxation policies and over-regulation of markets for the present condition, though they also recognized that global geopolitics and the weather are playing a part.

These points have been widely discussed and examined by analysts, so I will not add to them. What stayed with me from these conversations is something else: how little most investors understand about risk management.

Diversification alone does not reduce risk

Most investors I spoke to mistake diversification for risk management. They spread money across equity, fixed income and alternatives, mostly gold, silver and REITs. Then they spread it again within each: market cap, sectors, fund managers, bond duration and so on.

What gets missed is that diversification reduces risk only when the assets in the portfolio do not move together. It is low correlation that does the work, not the number of holdings. Three things follow from this.

·         Market cap and sector spread helps little if the overall portfolio beta stays high. In a falling market most stocks fall together, only by different amounts.

·         Several fund managers do not mean several different portfolios. If their holdings overlap, the portfolio is more concentrated than it looks. Check the overlap before adding the next fund.

·         When the weakness comes from macro and geopolitical factors, correlations rise and most assets fall together. That is what we see now. In dollar terms, gold is about a quarter below its January peak and silver is down by nearly half. Bond yields have risen to multi-year highs, the rupee has been hovering around 96 to the dollar, and the Nifty is down ~15% from its September 2024 peak. The assets that were meant to cushion the equity portfolio fell along with it.

The third point also shows the limit of the idea. No asset stays uncorrelated in every situation. In March 2020 even gold was sold, because everyone wanted cash. So, the question to ask is not only whether the assets are different, but whether they will still be different when it matters.

A fixed return is not a risk-free return

A bond, or a bond fund, that you may sell before maturity does not give a fixed income in the sense most investors understand it. Its price moves with yields, and yields have gone up. Only a bank deposit, or a bond that you will hold till maturity, gives a return known in advance. Even these are not risk free. They carry credit risk, reinvestment risk and inflation risk.

Gold: where did the return come from?

Gold carries currency and policy risk too. Take the period since the October 2025 peak. Gold in dollars is down by about 3%, but in rupees it is up by about 15%. In the same period the rupee is weaker by about 8%, and the import duty was raised in May from 6% to 15%, which adds about 8.5% to the landed price. Put these together and the entire return in rupees comes from the weaker currency and the higher duty. The metal itself gave nothing.

The risks everyone is watching

Most investors and fund managers named the risks that are visible today. A strong El Nino pushing up food inflation, a further rise in crude oil prices, and a collapse of the debt-funded global AI trade leading to a Lehman-like credit event were the ones cited most. These are fair concerns, and seeing a risk is the first step in managing it.

But even for these, there is little action. In India, derivatives are used mostly for speculation and rarely for hedging. The latest SEBI study found that nearly 88% of individual F&O traders lost money in FY26.

The risks nobody is watching

What troubled me more was that none of the participants mentioned an event that cannot be foreseen today. Yet if we look back, the events that hurt investors the most were rarely on anyone’s list. Few expected Lehman to fail in 2008. No list of risks in January 2020 had a worldwide lockdown. Demonetization in November 2016 came without a warning.

So let me stretch the mind a little. I am not saying any of the following will happen. My point is that each is possible, and a portfolio built only for visible risks would not survive it.

·         Rules change overnight. India nationalized banks in 1969 and had gold control until 1990. In May this year, the import duty on gold went from 6% to 15% by a single notification, and the Prime Minister asked citizens to curb gold buying for a year. What if a government under fiscal and currency stress goes further, with price caps, windfall levies or limits on what households can hold?

·         Market plumbing fails. A cyber-attack takes exchanges, depositories or payment systems offline for a week. Positions cannot be exited, margins cannot be paid, and there is no price to act on.

·         A big seller of gold appears. Central banks have been the steadiest buyers. China’s central bank has added gold for 23 months in a row and now holds about 2,400 tonnes. What if it sells 500 tonnes in the open market, roughly a fifth of its holdings and almost five times what it has bought this year? A sale of that size would hit the price and the story behind the price together.

·         Old rivals become partners. The US and Russia are seen as arch rivals, and that perception shapes much of the US–Europe relationship. Yet they fought on the same side in the Second World War and, apart from a short American intervention in the Russian civil war in 1918–20, have never fought each other directly. A thaw has already begun: this month the US waived some sanctions to let Russian diesel reach the market, and Moscow has called it a model for further deals. What if this grows into a durable economic understanding? Europe’s security assumptions, energy flows, defence spending and many investment themes built on the rivalry would need a rethink.

·         The story behind a metal changes. One of the main arguments for silver has been industrial demand, and its largest industrial user is the solar panel. Manufacturers are already using less silver per cell and moving towards copper. Silver used in solar fell 6% in 2025 and is expected to fall another 19% this year. Silver has also dropped by nearly half from its January record of about $121 an ounce. Most of that fall was a speculative spike unwinding, so I do not blame substitution for it. But it shows how fast a price can move once the story beneath it weakens.

·         Europe comes apart. EU members fall out over immigration policy and the union breaks up. Each member becomes a closely guarded jurisdiction, politically and economically. Property prices could fall sharply, unemployment could rise, inflation could stay higher for longer and sovereign defaults could stop being rare.

To most investors these examples may look farfetched, even the delusions of a paranoid mind. But none of them is without a precedent in history, and so none is outside the realm of possibility.

Why risk management gets ignored

Risk management is perhaps the most ignored and misunderstood part of investing in India. Investors mostly lack awareness. Intermediaries limit themselves to regulatory compliance. Exchanges are focused on smooth settlement. Regulators are busy balancing investor protection with the development and orderly functioning of the capital markets. None of them is doing anything wrong; each is doing what its mandate asks. But the result is that nobody owns the job of telling the investor what risk really means.

To me, risk management comes down to three things: holding assets that do not all fall together when it matters, hedging the risks we can see, and keeping enough slack to survive the ones we cannot.

Summary

•       Diversification reduces risk only when assets do not fall together. Check how your assets behaved in bad times, and check the overlap across your funds.

•       A fixed return is not a risk-free return. A bond you may sell before maturity is not fixed income.

•       When you read a gold return, separate the metal from the currency and the import duty.

•       Visible risks can be hedged at a cost. Invisible ones can only be survived. Plan for both.

•       Test your portfolio against a long, deep fall in everything at once. If you would be a forced seller, fix that first.

A closing thought

The Bhagavad Gita (18.14) lists five factors behind every outcome: the seat of action, the doer, the instruments, the many kinds of effort, and fifth, daivam – fate, or the unseen:

अधिष्ठानं तथा कर्ता करणं च पृथग्विधम् । विविधाश्च पृथक्चेष्टा दैवं चैवात्र पंचमम् ॥

Our models and spreadsheets deal with the first four. Risk management is the effort to leave room for the fifth.

Just like that

Until a few years ago, the baggage tags on all hand baggage were mandatory for all air passengers. The security personnel must stamp these tags for security clearance. Often you lost the tag while waiting for your flight; or the security personnel missed stamping the tag and you did not notice it; or the wet stamp ink got erased before you reached the flight gate. The security personnel at the gate would not let you board the flight and you had to scramble to get the tag stamping again. Then one fine morning some bureaucrat decided that hand baggage does not need to be tagged and stamped. Maybe an old parent of some top bureaucrat or politician or judge was made to run to get a tag stamped, which triggered this change in the mandate.

A rule that irritated passengers every single day went away with the issue of a simple circular. I wonder why it took so long, and what else is still waiting.

We face many similar situations in our routine life which makes us wonder why these rules exist and who will take the decision to change these rules to make our already stressful lives slightly easier. For example, have you ever been in any one or more of the following situations:

Rules that nobody looks at again

The missing stamp. A form or an application for your business goes to the bank or a government office. It is complete, signed and the figures are right, but the rubber stamp is missing, so it comes back. In most cases the stamp tells the clerk nothing that the signature and the company name do not already say. It stays because it is on the checklist.

The tree. A tree stands on a busy road and chokes the traffic. Court orders and tree protection rules do not allow it to be removed, and I understand why, because our cities have lost far too many trees. But a jam that runs for hours every day burns fuel, wastes time and adds to pollution too. I have not worked out the numbers, but I doubt the tree is winning that trade. The rule says no, and seems to have no easy way of saying yes with conditions, such as shifting the tree or planting many more elsewhere.

Rules that are fine on paper, but not at the counter

The barricade. A police barricade narrows the road and slows everything down, but nobody is checking anything. Cars crawl through a barrier that has no one to stop them. We pay the delay and get no security.

The security check. At malls, hotels and office buildings, it can take 20 minutes to clear the “security check”. The guard asks you to open the trunk, looks at it for a second and shuts it. He does not seem to know what he is looking for, and most of the time he does not even look at what is stuffed inside. Call it anything, but not a security check. We go through this almost every day.

The bank and Aadhaar. Your passport and driving license carry the address of your hometown. Your bank account, phone connection and LPG connection were given on the basis of your Aadhaar card, which carries your current address. Now the bank refuses Aadhaar as address proof for re-KYC. This refusal may not be strictly as per the RBI rules, but is common in practice.

Offices that do not talk to each other

The address loop. You move to a new city and rent a house. Now the address has to change in your passport, bank account, driving license, LPG connection, phone connection, voter ID, mutual funds and so on. Each office wants a document that another office issues, and the order in which you do things decides whether you get out at all.

The repeat test. The doctor at a hospital or clinic does not accept the reports from another hospital or an independent lab, and wants you tested again at a lab of his choice. Sometimes he has a fair reason. The report may be old, or the method may be different, and a treatment decision should not rest on a stale number. But when it is a routine test from a good lab done last week, the repeat is only an extra cost. From the patient’s side, I cannot tell which of the two it is, and that is the real problem.

The jam that was not there

You are stuck in a long jam. After crawling for half an hour you reach the end and find nothing at all that was causing it. You just drive away. Traffic people call it a phantom jam. Hours ago someone took a wrong turn or braked a little too hard, and the one behind braked harder, and the wave kept travelling backwards long after the first driver was gone. A small mistake somewhere, and thousands of people paying for it for hours.

With great powers comes no accountability

These instances reflect, inter alia, on the efficacy of our governance system, awareness of our society and how we look at the process of reforms. I would not say the whole system is broken. My reading is narrower. Making a rule has an owner, but removing one has none. An officer who adds a check is safe and often has no accountability. An officer who removes one carries the blame if something goes wrong later. There is no incentive for reforms.

I shall be happy to hear the views of the readers before I write more on this subject next week.

 

De-rating of Indian equities – cyclical or structural? - 3

As observed in my previous two posts (see here and here), I am inclined towards the view that the derating of Indian equities, compared to its historical averages, is partially structural.

The cyclical factors like El Nino, geopolitical uncertainties, inflation & rising bond yields in developed economies, lack of domestic investment opportunities in currently popular themes like artificial intelligence, semiconductors, etc. may be responsible for the poor performance of Indian equities to some extent. Statistically speaking, reversion to the long-term averages may also be a factor in correction in the equity prices from September 2024 high.

However, a part of the derating could be structural and we may not see the benchmark indices trading at 20-22x PE ratio in the short to midterm. Sub-optimal execution; lack of growth accelerators; a weakening perception about democratic institutions; policy unpredictability; stagnant real wages clouding demand acceleration; waning demographic dividend; and poor risk appetite of private enterprise does not augur well for any material rerating of Indian equities in the short to midterm.

Let me be clear about what this does not say. It is not a call that markets will fall. It only means that I should not count on rising multiples to do the work for me. If the PE ratio stays where it is, returns will have to come from earnings growth and dividends. And if the cyclical part turns out to be bigger than I think, I will have been too cautious. I am ready to pay that price.

Investment strategy adjustments

Over the next three years, I am considering the following changes to my own investment strategy.

·         Cyclical equity as a separate asset class. Besides strategic equity, I will add cyclical equity to my standard asset allocation. To begin with, both will get equal weight. Strategic equity is the long-term core. Cyclical equity is the money I put to work only when the cycle in a sector turns in favor. Since this part will often sit in cash waiting for a trend, my actual equity exposure will frequently be lower than the headline number.

·         Lower growth, higher cost of capital. For most companies, I will moderate my terminal growth and raise my cost of capital assumptions. This brings down my fair value benchmarks. Fewer stocks will look cheap, and that is how it should be if I do not expect multiples to expand.

·         No buy and hold for direct equity. I will keep this strategy only for diversified mutual funds. With a single stock, holding through a full cycle without a view on the multiple can give back all the gains. For direct equity, I will need a clear exit point, either when the thesis plays out or when the price crosses my fair value.

·         More patience with cyclicals. This applies especially to materials, industrials and financials. Instead of staying invested all the time, I will prefer to hold cash until a definite cyclical trend emerges in a sector. Then I will take concentrated, sizeable positions. I will miss the first part of the move, and I accept that. The bigger risk is concentration, so I must size each position in a way that a wrong call is survivable.

·         Avoid consumer staples. I will stay away unless a compelling opportunity emerges, like gross undervaluation or a special situation. Staples volumes depend on the average household, whose real income has not grown much, and the stocks rarely come cheap. I will focus on aspirational consumption only, where the spending comes largely from upper-income households.

·         Avoid companies that earn most of their revenue from government contracts. When one customer is the government, the company has little say on pricing, payment timelines or policy changes. This fits poorly with my concern about policy unpredictability. It also means that my industrial exposure will be limited to companies driven by private demand.

·         Avoid public sector monopolies and oligopolies. In these companies, the interests of minority shareholders are not the first priority. Pricing, dividends and capital allocation tend to follow what the government needs at that point in time. The risk of competition emerging from the private sector is also very high in these companies.

·         Avoid services and consumption companies with unusually high gross margins that are open to policy restrictions like price controls. Very high margins invite the regulator sooner or later. Private hospitals are one example that comes to mind.

What could change my mind

I do not see these adjustments as permanent. If real wages start rising, private capex picks up, earnings growth accelerates for several quarters in a row, and policy becomes more predictable, I will have to admit that more of the de-rating was cyclical than I assumed. I will review the framework once a year, and sooner if the evidence changes. But for now, I will stay with my current assumptions.

Summary

·         A part of the de-rating is structural. Do not depend on PE expansion for returns.

·         Lower fair values mean being fussier about price. Holding cash is a decision, not a failure.

·         Hold diversified funds for the long haul. Hold direct stocks only with a clear exit plan.

·         In cyclicals, wait for the trend to show up, then size up, but keep position sizes survivable.

·         Be careful with businesses where the government is the main customer, the owner or the regulator.

 

De-rating of Indian equities – cyclical or structural? - 2

Continuing from yesterday (see here)

While it is best to leave the task of examining in detail the nature of derating of Indian equities to the experts, I would like to share a few observations which suggest that the derating might not be entirely cyclical. There could be some fundamental issues that warrant discounting of “India Story” per se, and therefore derating of Indian markets on a durable basis.

What the premium rested on

The India story has always stood on three pillars: Democracy, Demography and Demand. For about two decades after 1991, the promise did hold out. Reforms came in almost every sphere. Financial market institutions were brought up to global standards. Rules on taxation, competition, capital controls, industrial licensing and infrastructure were liberalized to let private enterprise grow. Tax incentives helped IT services and merchandise exports, and the state backed physical and social infrastructure. The results showed in infrastructure, defence and space technology, digitalization of the economy, capital markets, poverty reduction, school enrolment and wider participation in democracy. Global investors liked what they saw. Money came in, and Indian equities earned a premium over their peers.

I had my doubts about the three pillars even then. In May 2017 I argued that these were as much challenges as advantages: “pseudo-socialist and quasi-feudal” political incentives lead to capital misallocation, a young population without skills is a liability, and aspirational consumption built on political promises rather than income growth is not sustainable. In June 2026 I went through each pillar again: stability of government without predictability of policy, a demographic dividend that is deferred, and demand that has stuttered. Foreign investors’ view of policy stability and enforcement has also slipped.

The premium was built on expectations, and it survived as long as something kept feeding those expectations. When the gap between promise and delivery became visible, the market began to charge for it. That is why I think part of the de-rating is a repricing of the story itself, and not just a change of mood.

What Indian companies build

Indian private enterprise grew up under scarcity, import substitution, licensing and protection, with limited access to foreign technology and capital. In that world, the winners were firms that secured scarce inputs, handled regulation well, learnt to absorb and adapt imported technology, and brought down manufacturing costs. Indian companies became very good at technology absorption, process engineering and cost control. They had little reason to invest in frontier discovery.

After 1991 this habit continued. In parts of Indian business, access to land, finance, natural resources, government contracts and regulatory permissions still counts for more than a better product. I call this rent seeking, and it is one reason why innovation is not rewarded as it should be. I am describing a pattern here, and not any particular company or group.

The R&D numbers show the pattern. Indian industry spends about 0.3% of GDP on in-house R&D, against a world average of about 1.5%. Total R&D spending in India is only 0.6 to 0.7% of GDP, and more than 60% of that is spent by the government. In 2021, the ten most successful non-financial companies had sales of about $277 billion and profits of $43 billion. Their R&D spend was less than $1 billion, which is about 0.3% of sales and 2% of profits. Their profit margins were nearly double those of counterparts in China, Japan and Germany, so it was not for want of money. The comparable companies in the US, China, Japan and Germany put 29% to 55% of their profits into R&D.

IT services is the clearest case. Despite all the tax and regulatory support over the years, the sector has leaned on labour-cost arbitrage and not on building its own technology and products. The top Indian software firms spend about 1% of turnover on R&D or less, against 10% or more for global peers. India has remained the back office for global businesses. The market is now repricing this. As AI reduces the effort needed for services work, the gains have to be shared with clients, and a company with few products of its own has little to fall back on.

Pharma has made its presence felt in global markets, but mostly as a low-cost manufacturer. The top five Indian companies spend about 6% of sales on R&D, the highest of any Indian sector, but well below the 17% to 20% spent by global leaders. Their average turnover of about $3 billion compares with $45 billion for the top twenty worldwide. Very few new chemical entities have come out of India.

Automobiles tell a similar story. The listed Indian auto companies among the world’s top 2,500 R&D spenders put 3.8% of turnover into R&D, against a world average of 4.8%. But that figure falls to just over 1% if we leave out the UK luxury subsidiary of Tata Motors. The better number comes from a business acquired abroad, and not from technology built at home.

Beyond these, Indian names are very few in the lists of premium global brands in fashion, food, automobiles, electronics or pharmaceuticals. A few new-age businesses are now building products and technology, but they are too few and too small to make a difference at the index level in the next five to ten years. It is telling that the market already pays more than 90 times earnings for some of them.

The market today pays high multiples to sectors where Indian companies are not known for innovation. Electronics manufacturing services trade at 54.6 times earnings, defence at 37 times and capital goods at 37.7 times. What investors are paying for is order books, government spending and the manufacturing opportunity, that is, scale and not originality.

So what is a fair multiple?

Now the question I started with. Does an emerging market dominated by commodities, rent-seeking private enterprises and inefficient public enterprises deserve a multiple in line with developed markets? An honest answer would not be an emphatic yes.

But the Nifty is not at a developed-market multiple today. On FY27 earnings, India trades at 18.6 times. That is below the US (20.9) and Japan (22.1), but above Germany (16.4), the UK (12.7) and the emerging markets index (11.4).

With a forward RoE of about 14.7% and a large services sector, I do not think India deserves a pure commodity multiple of 8 to 10 times. But I doubt investors will be willing to pay 20 to 22 times again, either. The Nifty at 17.2 times earnings already sits between the two, closer to the upper end. That means part of the adjustment may already have happened.

Where this leaves us

To this extent, I would say the de-rating of Indian equities is partially structural. The premium was paid for a story, and the story has not been delivered in full: companies that build and invent, policies that stay predictable, incomes that grow for the many and not just a few. What I cannot say yet is how much of the adjustment is behind us. For that we need to look at the temporary factors, at the difference between the index and the broader market, and at the possibility that this is mean reversion after very generous few years.

…to continue tomorrow

Also read

India’s fading premium

What’s bothering Indian equity markets

India’s private capex: reading beyond the headline

Democracy, Demography and Demand

New 3Ds - disappointment, dismay and disillusion

 

 

De-rating of Indian equities – cyclical or structural?

One of the most popular arguments for investing in Indian equities is the fall in PE multiple of benchmark indices relative to (i) its historical averages and (ii) global emerging markets. Motilal Oswal Financial Services, estimates that currently, Nifty is trading at ~18% discount to its long-term average price-to-earnings ratio and 12% discount to its long-term average price to book ratio. The MSCI India Index is trading at a 35% premium to the MSCI EM Index, materially below its historical average premium of 72%.

 ​

​While the fact of de-rating of Indian equities in recent years is indisputable, the nature of this derating is a topic of debate, in my view. It needs to be examined whether this derating of valuation is cyclical and therefore offers a good opportunity to increase exposure to the Indian equities; or is it structural; in which case it would also be worth examining whether there is scope for further derating, and therefore investors may look for curtailing their exposure to the Indian equities in their standard asset allocation matrices.

This examination would involve finding answers, inter alia, to the following questions:

(a)   What factors led to the Indian markets trading historically at a premium valuation compared to the global peers? Are these factors still prevalent and support the argument for a premium valuation for the Indian equities?

(b)   Is the derating of Indian equities purely due to temporary reasons like geopolitical uncertainties, inflation, rising global bond yields, currency depreciation, lack of domestic investment opportunities in currently popular themes like artificial intelligence, semiconductors, etc.?

(c)    Are there any reasons to believe that the current phase in the global economic, political, geopolitical and development cycle has weakened the argument for a long term “India Story” on a durable basis?

(d)   Is the derating for the “India Story” per se; only for the benchmark indices as several mid and small cap stocks trade at elevated valuations; or listed equities, or all of these?

(e)   Could this derating be merely a “mean reversion”?

…to continue tomorrow

Take it or leave it

The Indian equity markets continue to notably underperform its global peers, despite assurances of a resilient economy and decent corporate performance. Experts have attributed the underperformance to incessant selling by the foreign investors and geopolitical uncertainties. Both are valid reasons. But I do not think these explain the full picture.

Foreign selling is an effect, not a cause

Foreign portfolio investors (FPIs) have been net sellers in four out of the past five years. Obviously, they are not selling for fun. Something seems to have changed in how they see the risk and the return from India. The selling, therefore, tells us “what” is happening, not “why”.

Part of the “why” is global. Treasury bonds in the developed economies are yielding highest in over two decades, providing global investors a safer option to invest. The rupee is flirting with 96 to the dollar, which cuts dollar returns even when the Nifty stays flat. Neither of these is India-specific. They hit every emerging market.

Geopolitics is affecting India mostly through oil and other raw materials. Expensive crude, chemicals, metals, etc. means higher imported inflation and a weaker rupee. That is a real cost, but the economy is absorbing it. The RBI’s own estimate for FY27 growth stands at 7.1%, after the oil shock and the weaker rupee are already in the numbers. Domestic institutions are also buying, so net flows (FPI plus DII) remain positive. A market that falls under these conditions is telling us that the risk premium foreign investors are willing to pay for India has changed.

The one cause that is in our own hands

I think, among other things, policy and legal uncertainty is one of the reasons global investors are staying away. I have highlighted this before (see here). The government itself acknowledged it in an Economic Survey (see here). Over the past decade, India has seen more than one sudden shock. The retrospective tax of 2012 was repealed only in 2021, after costly arbitration losses. The higher surcharge on FPIs in the 2019 Budget was rolled back within weeks. Each was corrected in the end. But the correction came after the damage, and that pattern is what erodes the trust between government and enterprise.

Two recent instances are noteworthy in this context.

Tiger Global: the ruling and the repair

In January this year, the Supreme Court ruled that Tiger Global must pay capital gains tax in India on its 2018 sale of Flipkart shares to Walmart. The court found that Tiger Global’s Mauritius entities acted as simple conduits for tax avoidance rather than active local businesses. The court emphasized that a Tax Residency Certificate (TRC) issued by Mauritius no longer automatically guarantees tax treaty relief. Tax authorities can look past paperwork to see where real control and business decisions happen. The judgement said India’s General Anti-Avoidance Rules (GAAR) can override older treaty benefits if an arrangement lacks commercial substance, even for older investments.

To be fair, I would not defend a structure with no commercial substance. The court was enforcing an existing anti-avoidance law, not inventing a new one. The real difficulty is for investors who believed that investments made before April 2017 were protected, which is what the 2016 treaty protocol seemed to promise.

On March 31, 2026, the CBDT amended the GAAR rules so that income from the transfer of investments made before April 1, 2017 stays outside GAAR. That is a welcome step. But the issue may not be closed yet. The “substance over form” reasoning and treaty-level anti-abuse clauses are still available to the tax department, and it is not clear that the relief reaches Tiger Global itself. Shock first, patch later, some doubt left over. That is a worrying pattern for investors.

Prima facie, this mostly concerns private equity and venture capital investors, not the FPIs selling listed shares. But long-term capital talks to each other. What one set of investors learns about exit risk soon becomes part of how everyone prices India.

Hospitals: a risk building, not yet a shock

The healthcare sector in India has attracted substantial foreign capital in the past decade. Foreign investors now hold material stake in most of the corporate hospital chains in India. Recently, the Supreme Court of India criticized corporate hospitals for overcharging patients and suggested that they should be operating as service providers rather than attempting to maximize profit. The government is yet to clarify its stand on the issue, creating significant uncertainty for foreign investors who have invested heavily in Indian hospitals.

If a margin cap is actually imposed, it will come with little notice and no transition. Investors have seen that film before.

What I make of it

The message from these episodes seems to be that India is no haven for those looking for tax arbitrage or policy loopholes. The call reads as “either play by the rules or leave”. That is a fair position for any country, provided the rules are clear and known before the money goes in. Investors can live with strict rules. What they cannot price is a rule that gets interpreted or redrawn after they have invested. For now, foreign money’s verdict seems to be to trim exposure.

Investor takeaways

·         FPI selling is not a verdict on India’s growth. The growth is decent. But do not dismiss it either; markets sometimes see risks before the data does.

·         Watch the follow-through, not the headline. The final government stance on hospital pricing, and how the tax department applies the GAAR amendment in pending cases, will tell us more than any media headline.

·         Treat price-regulation risk in listed hospital chains as a real input to valuation, not as noise.

·         Stay selective on FPI-dependent segments until there is more clarity. Domestic flows are a cushion, not a substitute.

·         Do not assume that a patch for one problem means the pattern has ended. Look at how quickly and how clearly the next one is handled.