Last week I raised a question that I believe lies at the heart of India’s current economic anxiety: why, despite the government and the RBI signaling growing concern — which, by historical precedent, should calm markets — are investors, particularly foreign investors, refusing to be reassured? (see here)
In my view, the disbelief is neither irrational nor transient. It is rooted in a confluence of structural, socio-political, and corporate factors that have been building for several years, and which the present crisis has simply made impossible to ignore. I would group them under four broad heads.
Macro weakness: Old problem, but with unfamiliar depth this time
India’s external and domestic macroeconomic position has deteriorated in ways that go beyond the cyclical discomfort of a typical crisis.
1. Balance of Payments under structural strain: The current account deficit has widened, driven by persistently high energy import costs in a period of elevated West Asia tensions. More concerning is the composition of financing: net FDI has turned negative, and FII outflows have been large and sustained over three years. India is, for now, plugging the gap through forex reserves and debt flows — a less stable combination than equity-led capital.
2. The rupee and the RBI’s impossible dilemma: The INR has weakened materially and has been among the worst-performing major currencies over the past year. The causes are multiple: BoP pressure, a widening yield differential with the US, and a rising tide of outward remittances and overseas portfolio investments by domestic HNIs through the RBI’s Liberalized Remittance Scheme. The RBI’s response has been constrained: hiking rates aggressively to attract foreign flows and defend the rupee would suppress growth in an already sluggish economy. Keeping rates low risks currency depreciation and imported inflation. This is not reluctance — it is a genuine policy trap, and investors know it.
3. Inflation without growth: Rising inflation, driven by a weaker rupee and adverse weather, is compressing real purchasing power. The combination of rising prices and stagnant to declining real wages is particularly damaging to private consumption — the engine that India needed to fire in the absence of strong export or investment demand. The consumption story, which was central to the India bull case, looks increasingly fragile.
4. Fiscal space is narrowing: The government’s fiscal position is under pressure from multiple directions: elevated subsidy commitments, defence spending following the May 2025 tensions, and weaker tax revenues in a slowing economy. This is reducing the government’s capacity to compensate through public capital expenditure — which had been the primary growth driver for the past four years.
5. Valuation offered no cushion: Indian equities entered this downturn at stretched valuations. The Nifty 50 was trading at 20–22x forward earnings even as earnings growth was decelerating. When negative macro news lands on an expensive market, the correction can be disproportionate — and that is exactly what has happened. There was no margin of safety built into prices.
Socio-Political challenges: The harder conversation
These are the factors that investors discuss in private but rarely commit to paper. I will try to be precise rather than polemical.
1. The pivot toward consumption control: The Prime Minister’s recent appeal for austerity — asking citizens to cut fuel use, forgo overseas travel, and defer gold purchases — sent a signal that many investors read as a reversion to pre-1991 thinking. (I discussed this at length in my earlier post, ‘Austerity vs. Reform’.) Whether that reading is entirely fair or not, the market impact is real: investors who were already watching the reform pipeline closely have grown more anxious about whether the government will reach for supply-side reform or demand-suppression controls.
2. Subsidies, welfare spending, and labour market effects: The government’s increasing reliance on direct benefit transfers, free ration schemes, and cash transfers to consolidate its political base may not be inherently wrong — but its side effects on the private sector labour market are real. Labour availability and motivation in certain sectors have been affected by welfare floors that reduce the incentive to accept low-wage formal employment. This is a structural drag on manufacturing-led growth.
3. Education quality and the demographic dividend at risk: India’s single most important long-term economic asset is its young population. But that asset is only valuable if the population is educated and skilled. The data on learning outcomes — whether ASER surveys or international comparisons — tells a deeply uncomfortable story. If the demographic dividend passes without a commensurate investment in human capital, it becomes a demographic burden. Sophisticated long-term investors are beginning to price this in.
4. Governance quality and institutional confidence: Several global investors have expressed, with increasing directness, concern about the quality and independence of Indian institutions — the judiciary, the regulatory apparatus, and law enforcement. These concerns are not new, but they have intensified. When investors cannot trust that contracts will be enforced, that regulations will be applied consistently, or that disputes will be resolved impartially, the risk premium they demand rises — sometimes dramatically.
Corporate growth visibility: The profit-investment paradox
Perhaps the most paradoxical aspect of the current situation is that Indian corporate balance sheets are in excellent shape — and yet confidence in future earnings is low. The reasons for this are structural.
1. Profits without purpose: As Chief Economic Adviser Dr. V.A. Nageswaran has noted, corporate India tripled its net profits between FY21 and FY25, while cutting its debt-to-equity ratio from 139% to 94%. Cash reserves swelled from ₹9 lakh crore to ₹16 lakh crore. Private investment as a percentage of GDP fell to a 20-year low. The money is there. The willingness to deploy it in productive assets — factories, R&D, new technologies — is not. Instead, promoters are accumulating profits, setting up family offices, and increasing overseas investments. This is rent-seeking at scale, and it destroys future earnings potential even as it flatters current balance sheets.
2. The three large sectors offer moderate visibility at best: Financials, IT services, and FMCG collectively dominate index earnings. All three face meaningful headwinds. Financials are managing through margin compression and pockets of asset quality stress in the retail and MSME book. IT services is navigating weak global discretionary technology spending and the early disruptions from AI-driven efficiency gains on the demand side. FMCG is struggling with volume growth in a real-wage-compressed consumer environment. None of this is catastrophic, but none of it inspires conviction either.
3. Financial system stress is a risk, not just a concern: Rising financing costs and persistent inflation increase the probability of stress in the financial system — particularly in unsecured retail lending, microfinance, and small business credit. The RBI has been flagging this, and the market is beginning to price a higher probability of credit cost escalation than consensus earnings estimates currently reflect.
The changing global order: India’s ambiguity has a price
This is the factor that is perhaps most underappreciated in domestic commentary, but which global investors flag consistently.
1. Strategic ambiguity in a polarizing world: The ongoing West Asia conflict, the continued Russia-Ukraine war, and the accelerating US-China decoupling are forcing every country to make choices about where it stands in the emerging global order. India has, with considerable skill, maintained strategic autonomy — balancing relationships with the US, Russia, and the Gulf. That balancing act is becoming harder. The costs of ambiguity are rising: trade partners want clarity on supply chain alignment, technology partners want assurance on data security and geopolitical reliability, and capital allocators want predictability on which side of the emerging economic blocs India will ultimately sit. India has not provided those answers, and the uncertainty is keeping investment at bay.
2. The technology dependency trap: As Dr. Raghuram Rajan has written, India’s approach to the AI era risks repeating — and deepening — the mistake of the IT services era. India provides the land, power, and construction for data centres owned by US hyperscalers. The LLMs running on those servers are designed in California. The chips are fabricated in Taiwan. India contributes inputs; the intellectual rent flows out. This is not self-reliance. It is a sophisticated form of technological dependency, with stronger lock-in than the earlier IT services model. Investors who understand technology cycles are asking whether India has the innovation infrastructure to build the next layer — and the honest answer, today, is no.
The Real Reason for Disbelief
Taken individually, each of these factors would be manageable. Taken together, they describe a situation where the authorities’ panic — however genuine — may simply not be adequate to address the scale of what needs fixing.
Past crises — 1990, 2008, 2020 — had sharp triggers and identifiable remedies. The RBI cut rates; the government spent; the rupee fell and exports recovered; the crisis passed. The market knew what medicine was available and trusted that the doctor would administer it.
The present situation is different. The headwinds are structural, not cyclical. Rate cuts cannot fix a corporate investment drought driven by rent-seeking incentives. Fiscal stimulus cannot substitute for the human capital investment that was deferred over a decade. Forex intervention cannot sustainably defend a currency whose weakness reflects deep competitiveness questions. And no single policy action can resolve India’s strategic positioning in a fracturing global order.
Markets are not in disbelief because they doubt the government’s sincerity. They are in disbelief because they are looking at the medicine cabinet and wondering whether any of the available remedies actually treats the disease.
That is a harder problem than any previous Indian crisis has posed. And until investors see credible evidence of structural remedies — not just cyclical stabilization — the disbelief is likely to persist.
Also read
Markets in a State of Disbelief
Indian Economy – At an Inflection Point
Austerity vs. Reform: Which Way Are We Headed
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