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
What’s bothering Indian equity markets
India’s private capex: reading beyond the headline
Democracy, Demography and Demand
New 3Ds - disappointment, dismay and disillusion