Progress, Peril and Robustness - 2

Continuing from yesterday (see Progress, Peril and Robustness – 1)

Investment implications

A BIS report provides a clear map of where systemic risk is building, and reading it is a useful discipline before you decide how much risk to carry and where. Here is how I would prefer to incorporate the four pressure points highlighted in the BIS 2026 annual report in my investment strategy.

Not assuming the disinflation trade is safe

Markets have priced in resumption of the disinflation path that was underway before the Hormuz shock. The BIS’s own work suggests otherwise — energy shocks of this size have historically produced inflation effects that outlast the shock itself by a year or more, and the mitigating factors this time (anchored expectations, looser labour markets) are real but not guaranteed to hold if the shock persists. My own view: don’t fully unwind inflation hedges just because oil has pulled back from its peak. Real assets, select commodity exposure and inflation-linked instruments may still be relevant in a diversified book.

Separate the technology story from the financing story

I remain a believer in AI as a genuine productivity technology — the BIS’s own task-level studies show real efficiency gains. What worries me is not the technology; it is the financing structure around it. Circular financing arrangements — where the same dollar of capital seems to be creating revenue for multiple related entities — are exactly the kind of opacity that precedes a repricing. The practical takeaway: be diversified within your AI exposure rather than concentrated in the handful of hyperscalers and their closest financing partners, and treat any single-stock AI position as a venture-style bet, sized accordingly.

Private credit is not free lunch

The report flags that direct lending funds have quadrupled their exposure to AI and IT borrowers over five years, often with similar pricing and tenor despite growing concentration risk. Retail investors who have moved into private credit funds chasing yield should understand that liquidity terms in these vehicles can become binding constraints exactly when you need liquidity most. This is a reminder to price illiquidity properly rather than treat the extra yield as a free lunch.

Expect more volatile sovereign bond markets, not fewer

The BIS’s description of a fragile fiscal-financial nexus, where bond market liquidity can evaporate quickly, is a structural reason to expect higher volatility in developed market sovereign bonds over the coming years — not a one-off event, but a recurring feature. For fixed income allocations, this argues for staying closer to the shorter and intermediate end of the curve, and being selective about duration bets even when yields look attractive, since the BIS itself flags that governments may increasingly need central bank backstops to keep these markets functioning smoothly.

Reading the global report through a domestic lens

None of the four pressure points above originate in India, but all of them touch us, and in ways worth spelling out separately.

·         Energy dependence is our biggest transmission channel. India imports the overwhelming majority of its crude, and the BIS’s own exposure analysis places India among the emerging economies most affected by Hormuz-related disruption scenarios. A sustained oil price premium — even a modest one, well short of the panic peak — shows up quickly in our import bill, the rupee and the fiscal arithmetic. This is not a new theme for readers of this blog; it is the same fiscal-currency link I have written about before, just now driven by a fresh external trigger rather than a domestic one. (Read here and here)

·         Our macro buffers are genuinely better than in past crisis episodes, but they are buffers, not immunity. Strong bank balance sheets, healthy capital ratios and steady domestic institutional flows into equities have absorbed shocks well so far. That is a real strength. But a BIS report that flags global inflation persistence and fiscal fragility as base-case risks, not tail risks, argues for treating our own resilience as a cushion to lean on, not a reason for complacency about valuations.

·         India’s IT services sector sits directly in the AI capex cycle’s crosswinds. A continuation of the hyperscaler spending boom is a tailwind for the sector through cloud migration and AI-enabled services demand. But the BIS’s own warning about the sustainability of that capex — debt-funded, concentrated, partly circular — means a sharp AI capex slowdown, should it materialize, would hit sentiment toward Indian IT stocks even though our companies are several steps removed from the actual financing risk. Worth distinguishing between the operating exposure (mostly indirect and manageable) and the sentiment exposure (which can move faster than fundamentals).

·         The dollarization risk the BIS discusses is low for India today, given capital account management, but it is worth watching over a longer horizon as stablecoin regulation evolves globally and domestic crypto/stablecoin adoption picks up at the margins. This is more a five-year theme than a this-year theme.

·         On fixed income, the domestic story is somewhat more comfortable than the global one — our own fiscal consolidation path has been more disciplined than many advanced economies’, and RBI’s recent Financial Stability Report corroborates that domestic financial stress remains low by historical standards. But global yield volatility, if it persists, will still spill into our markets through FPI flows and benchmark repricing, so treat domestic bond market calm as conditional on the external environment staying orderly, not as a given.

To conclude: India’s relative position within this report is a source of comfort, not complacency. The buffers are real, but the report is fundamentally about a world where shocks have become more frequent and financial systems have become more interconnected in ways that are hard to see until they matter. Being well-diversified, avoiding concentrated bets on any single global narrative — AI, energy, or otherwise — and keeping some genuinely defensive assets in the mix remains the right posture, regardless of how sound our own banking system looks on paper.

There is a line from the Gita that I keep returning to in years like this one: योगस्थः कुरु कर्माणि सङ्गं त्यक्त्वा धनंजय — perform your actions established in yoga, having abandoned attachment. The BIS report, at its core, is a document about attachment: to easy financial conditions, to a single technology narrative, to the assumption that resilience shown once will hold indefinitely. The investor’s job, as always, is to keep doing the work — reading, rebalancing, staying diversified — without becoming attached to any one story about how the world must unfold.

Also Read

Progress, Peril and Robustness - 1

Progress, Peril and Robustness - 1

The Bank for International Settlements — the “central bank of central banks” — released its Annual Economic Report for 2026 in June. The report steps back from the daily noise of markets and tries to describe the plumbing of the global financial system — where the stress points are, and where the next one might come from.

I am briefly describing here what I gather from an extensive reading of the report. Tomorrow I will share my thoughts on its investment implications.

What the BIS is actually saying — In plain English

The title the BIS chose for this year’s report is itself a clue: “From resilience to robustness?”. The question mark is doing a lot of work. Their argument, stripped of jargon, is this: the world economy has shown it can absorb one shock after another without breaking. But absorbing shocks repeatedly is not the same as being structurally sound. Resilience is what you have when you are lucky and adaptable. Robustness is what you have when the foundations themselves are strong. The BIS thinks the world has had plenty of the former and not enough of the latter.

A year that came in two acts

Act one was surprisingly good news. Global trade absorbed the 2025 US tariff shock far better than anyone expected. Effective tariff rates settled near 10%, well below the 25%+ initially announced, and firms simply rerouted trade, ate margins, or front-loaded shipments. At the same time, a wave of AI-linked capital expenditure — data centers, chips, power infrastructure — became its own growth engine, particularly in the US, with spillovers across Asia’s export economies.

Act two was a reality check. In late February 2026, the conflict in Iran led to an unprecedented closure of the Strait of Hormuz — the corridor through which a huge share of the world’s oil and gas flows. Roughly 13% of global crude supply was cut off, a bigger shock than the 1970s oil crisis. Oil spiked over 60% in weeks. Inflation, which had been cooling nicely, jumped back up. Asia, being the most dependent region on Gulf energy, took the biggest hit.

Pressure points to closely watch for

·         Inflation is making a comeback. Fertilizer and plastics prices are up 30–50% on the back of the energy shock, and these costs are still working their way through supply chains. The BIS’s own modelling shows large energy shocks have disproportionately larger effects on inflation than small ones — this is not a linear story.

·         The AI investment boom is running hotter than its cash flows justify. The five largest hyperscalers are set to spend over a trillion dollars on AI capex through 2026, increasingly funded by debt rather than free cash flow. The BIS draws an explicit parallel with canal mania, railway mania, and the dotcom bust — genuine technological breakthroughs that still attracted more capital than commercial returns could justify.

·         Financial vulnerabilities are the amplifier, not the trigger. Equity valuations are stretched, risk premia have compressed to levels last seen before the pandemic, and a growing share of AI financing is “circular” — hyperscalers investing in AI labs that then commit to buying the hyperscalers’ chips and compute. The BIS flags this web of related-party financing as opaque and hard to unwind cleanly if sentiment turns.

·         Fiscal space has quietly disappeared. Public debt in advanced economies is near post-war highs. Cyclically adjusted primary deficits have nearly doubled since 2022 compared with the two prior decades. And critically, the arithmetic has flipped: bond yields now exceed nominal GDP growth in many countries, which means governments can no longer simply grow their way out of debt — they need actual primary surpluses.

A new and less familiar risk: the fiscal-financial nexus

Chapter II of the report is, to my mind, the most important part. The BIS describes a “new fiscal-financial stability nexus”: as governments issue more debt, non-bank financial intermediaries — especially leveraged hedge funds running basis trades — have stepped in to absorb a growing share of it. These funds rely on short-term repo financing that can vanish overnight. The old worry was banks holding too much government debt. The new worry is that market liquidity for government bonds can look ample for months and then disappear in days, forcing yields up sharply with very little warning. The BIS is candid that central banks may increasingly be pulled into acting as backstops for sovereign bond markets themselves, not just banks — a role that blurs the line between fiscal and monetary policy in ways that make both harder to manage.

And a quieter chapter on the future of money

Chapter III looks at stablecoins and digital money. The BIS’s verdict is measured but skeptical: today’s stablecoins fall short of what money needs to be — they don’t always hold value at par, the infrastructure is fragmented across blockchains, and the absence of proper know-your-customer checks on many wallets is a financial integrity problem. Where stablecoins matter more for the rest of us is the dollarization risk they pose to countries with weaker macro fundamentals — if households in such economies start preferring dollar-pegged stablecoins over their own currency, it chips away at monetary sovereignty. The BIS’s preferred solution is not to ban innovation but to bring tokenization into the existing two-tier system — commercial bank money plus central bank money — through projects like Project Agóra.

The moot point, in the BIS’s own framing, is whether the world can convert this year’s resilience into lasting robustness — by rebuilding fiscal space, keeping inflation credibility intact, and extending prudential discipline to the parts of finance that now sit outside the banking perimeter — before the next shock arrives. On their own assessment, the jury is still out.

…to continue tomorrow

 

India’s fading premium

The 3Ds: A Framework That Needs Revisiting

In a post in May 2017 (see here), I had argued that Democracy, Demography, and Demand — the 3Ds that global investors had long cited as India's structural pillars — were in fact the key challenges for sustainable economic growth, not straightforward advantages. I had warned then that "pseudo-socialist and quasi-feudal" political incentives often led to capital misallocation, that young demography uncoupled from skill formation was a liability not an asset, and that aspirational consumption driven by political promises rather than income growth was neither desirable nor sustainable.

Nine years later, that assessment has aged uncomfortably well.

The 3Ds remain the rhetorical foundation of every India pitch deck. But in practice, each of the three pillars has shown meaningful stress:

Democracy: Stability without predictability

The political stability that investors valued has been real. But stability of government and predictability of policy are different things, and the distinction matters enormously for long-term capital allocation.

Policy unpredictability — retroactive regulatory changes, sudden sectoral interventions, judicial reversals of contracts — has become a recurring theme in India's investment narrative. Enforcement agencies, whose independence from political direction is a minimum requirement for credible rule of law, have been perceived by many foreign investors as instruments of selective pressure rather than neutral arbitration. Whether or not this perception is entirely fair, it exists, and perceptions drive capital flows.

The consequences are visible in the data. India's share of global market capitalization has fallen to 3% in May 2026 — a 50-month low, down from a peak of 4.6%. Foreign portfolio investors have recorded outflows for three consecutive months, with CY26 YTD outflows from Indian equities totaling $25.9 billion. Large-scale FDI — the kind that reflects genuine confidence in contract enforcement and regulatory stability — has not arrived in the volumes the India growth story would logically support.

The weak contract enforcement mechanism and the perceived misuse of enforcement agencies may not be the headline reasons cited in FII exit reports. But they are the background conditions that make it easier for a global portfolio manager to reallocate to Korea or Taiwan when those markets begin to offer more compelling near-term returns. The institutional trust that transforms a structural growth story into sustained capital inflows requires more than a good narrative. It requires consistent, rule-bound behavior over many years. That work remains incomplete.

Demography: Dividend deferred

India has the world's largest young population. This is an extraordinary potential asset. It is also an extraordinary potential liability if not channelized properly — a point I made in 2017 & 2019 (see here) and which has not become less true in the interim.

The demographic dividend requires a specific set of preconditions: quality education at scale, practical skill formation aligned with the labour market, employment generation that absorbs new entrants faster than the workforce grows, and social infrastructure — healthcare, housing, transport — that keeps a young population productive rather than frustrated.

India's record on these preconditions has been mixed. The headline growth in formal employment has not kept pace with the scale of the young population entering the labour market each year. Real wages for a large segment of the working population have not kept pace with food and services inflation, eroding purchasing power and suppressing the consumption-led growth that was supposed to be the demand side of the demographic story.

The rise of aspirational consumption driven by credit and political transfers — rather than genuine income growth — has created demand that is more fragile than it appears. When that fragility is tested by food inflation, fuel price hikes, or job uncertainty, the consumption numbers disappoint. Which is precisely what has been happening.

Demand: The engine that stuttered

The third D — Demand — is where the recent underperformance is most directly visible in corporate earnings.

The Nifty 50 registered only 5% EPS growth in FY26, following a 16%-plus CAGR in the five years from FY20 to FY25. The 4QFY26 result season marked the eighth consecutive quarter of single-digit earnings growth for the Nifty since the pandemic era.

The Consumer sector P/E, at 38.5x, sits at a 10% discount to its 10-year average. FMCG companies are taking calibrated price hikes, reducing grammages, and cutting marketing spend — the classic playbook of businesses navigating margin pressure from both sides. Companies need crude to remain below $90/bbl to protect margins; it is currently running at $106/bbl.

IT — historically the sector that combined India's demographic and educational advantages with global demand — has delivered a structural rather than cyclical disappointment. Technology trades at 16x, a 26% discount to its 10-year average. Infosys guided for 1.5-3.5% constant currency revenue growth for FY27. HCL Tech guided 1-4%. AI-led pricing pressure, early signs of revenue deflation in legacy services, and the recognition that previously assumed-stable revenue pools may be "deflatable" have reframed the sector's growth narrative. The dividend yield for technology has risen to 4.7% — the market's way of saying it expects income, not growth, from these businesses going forward.

Private sector capex — the investment cycle that was supposed to follow the post-COVID infrastructure push — has not materialized with the breadth and depth anticipated. Corporate balance sheets are healthier, but the willingness to commit to large expansionary investments in an environment of demand uncertainty and elevated input costs is limited.

The fourth D that was missing: Depth

There is a fourth argument that has historically been made for India's valuation premium — the argument of market depth and breadth. India has one of the largest equity market ecosystems among emerging markets, with hundreds of listed companies, a developed institutional framework, robust retail participation through the SIP culture, and a regulatory infrastructure that compares well against peers.

This argument has real merit. The domestic institutional base — DII inflows of $41.4 billion in CY26 YTD — has been the primary shock absorber in a year of intense FII selling. Without this structural domestic bid, the market's correction would have been considerably deeper. The SIP culture is genuinely transformative and represents a democratization of equity ownership that has few parallels in emerging market history.

But the depth argument has a counterweight that is harder to dismiss: only a handful of Indian companies have achieved genuine global scale and performed consistently across cycles. The ambition to be a technology and innovation powerhouse has not translated into companies that compete at the frontier globally. India seems to have lost ground in the race for new technologies — semiconductors, AI infrastructure, advanced manufacturing — that are reshaping where global capital flows. The result is material liquidation of foreign portfolio and private equity investments, as global allocators redirect capital toward markets where those technology bets are being won.

India's equity market is deep in breadth but not yet in the kind of globally competitive corporate quality that sustains a premium over decades. Until that changes, the premium will remain contested.

The honest assessment

The two-year time correction in Indian equities is not a market failure. It is the market performing its basic function — pricing out a premium that was built on expectations that were not met.

The 3Ds that justified India's premium were not fictional. Demographics remain real. Domestic demand potential remains real. The political stability that enables long-term planning remains intact. The institutional market infrastructure is better than it has ever been.

But structural potential is not the same as structural delivery. The gap between what India's story promises and what it consistently delivers — in earnings per share, in globally competitive companies, in predictable regulatory environments, in real income growth for the median household — is the gap that the derating is closing.

Investors who bought the India story at 25x or 28x forward earnings were paying for a future that is arriving, but later and more modestly than they assumed. That is not a new lesson. It is the same lesson that Indian equity markets have administered, periodically and without apology, to those who confuse a compelling narrative with a guaranteed outcome.

The current period of underperformance may be nearing its end. Valuations are more reasonable. The domestic institutional base is structurally supportive. The FY27 earnings cycle, if it delivers, could re-establish the growth narrative that justifies a premium over peers.

But the condition of a sustained return to premium is clear: India must begin delivering on the scale that the narrative has always promised. Companies of genuine global quality. Policy environments that attract rather than frighten long-term capital. Real income growth for the majority, not just the top decile.

Until those conditions are met, the premium will remain, at best, moderate.

And moderate is not what India's story was supposed to be.

Also read

What’s bothering Indian equity markets

Overcome the inertia first, rest will follow

Democracy, Demography and Demand

New 3Ds - disappointment, dismay and disillusion

Demographic accountability

What’s bothering Indian equity markets

There is a particular kind of pain that is harder to bear than an outright crash. It is the slow, grinding disappointment of a market that refuses to go anywhere — up or down — for so long that investors begin to wonder whether they have misread something fundamental. Indian equities have been delivering precisely that experience for the better part of two years.

For the 24 months ending 5th June 2026, the Nifty 50 and the Nifty Smallcap 100 have yielded essentially nothing — zero return, net of the daily noise. The Nifty Midcap 100 has managed a modest positive, but even that flatters a journey that included a sharp crash and an equally sharp recovery in the intervening months, implying a CAGR of less than 5% for the period. This is what a time correction looks like. Not a bear market. Not a recovery. Just stagnation, dressed up in daily volatility to keep you from sleeping.

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The global context makes the domestic picture worse. In a period when most of the world's major equity markets have delivered strong returns — Korea up 93% in USD terms year-to-date, Taiwan up 55%, Japan up 29%, MSCI EM up 25% — Indian equities have fallen 15% in USD terms in 2026 alone. And on the ten-year measure that strips out shorter-term noise: MSCI EM has now outperformed MSCI India with a 10-year CAGR of 8.1% versus India's 7.4%.

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For an index that has historically commanded a 73% P/E premium over EM — a premium built on three decades of structural optimism about India's potential — this is a significant and humbling reckoning.

The valuation picture

Before asking why this has happened, it is worth being precise about what has happened to valuations.

As per the Motilal Oswal Bulls & Bears Valuations Handbook for June 2026:

·         The 12-month forward P/E of the Nifty 50 stands at 18.6x, against a 10-year average of 21x — an 11% discount to history.

·         The 12-month forward P/B ratio is 2.7x, against a 10-year average of 2.9x — a 5% discount.

·         India's market cap to GDP ratio has corrected from 129% in March 2024 to 115% in March 2026. Still above the long-term average of 87%, but no longer in the exuberant territory of 2024.

·         The PE premium of MSCI India over MSCI EM has collapsed from a historical average of 73% — and a peak of 150% in November 2022 — to a moderate 17% as of end-May 2026.

These are not crisis-level numbers. The Nifty is not cheap in any absolute sense. But the direction is unambiguous: the premium that India has historically commanded over its peers is being systematically stripped away.

It is time to ask the question; we have avoided asking for a long time — is the India premium still deserved?

…to continue tomorrow

India markets - two extremes, and something in the middle

India's consumer economy is not a single story moving in one direction. It is at least two stories moving in opposite directions simultaneously. Investors who treat it as one thing are likely to be surprised — in both directions. Those who understand the split, and position accordingly, may find it one of the more durable structural themes of this decade.

Walk into any grocery store in a middle-class neighborhood today and ask the owner what is selling. The answer is likely to surprise you. Cheaper rice. Loose dal instead of packaged. The economy brand of oil, not the one they used to buy. In some cases, smaller quantities of everything.

Now walk into a luxury car showroom in the same city. Waiting lists. New models selling above sticker price. Customers paying for options they did not even know existed six months ago.

Both of these things are happening in India right now. At the same time. In the same cities. And they are not contradictions — they are two sides of the same economic reality.

Why many Indians are buying less, and cheaper

The idea that Indian consumers prefer low prices is not new. It is often described as a cultural trait — as if thrift were somehow in the national character. That framing is misleading. Indian consumers are not cheap by nature. They are rational. When budgets are tight, they make trade-offs. When budgets loosen, they upgrade — fast.

What is happening right now is that budgets are tight. And for many households, they are tighter than they were three years ago.

Food prices have risen sharply. A kilogram of tur dal that cost Rs. 80 a few years ago now costs close to Rs. 160 in many markets. Edible oil prices remain elevated. Wheat flour costs more. These are not luxuries — they are the building blocks of everyday meals for most Indian families.

At the same time, wages for a large portion of the working population have not kept pace. Real wages — what your salary actually buys after accounting for inflation — have fallen for many workers in the informal economy. The result is a household that earns roughly the same in rupees but can buy meaningfully less.

The response is predictable and rational: buy cheaper. Buy less. Buy local brands instead of national ones. This is what economists call downtrading, and multiple grocery retailers I spoke with in recent months confirmed it is happening in staples across the board — pulses, oils, rice, flour, and even basic hygiene products.

The apparel market tells the same story. Footfall at economy chains like Zudio and Reliance Trends has risen noticeably. Budget online platforms like Meesho have grown into very large businesses by serving exactly this segment of price-pressured shoppers, primarily in smaller cities and towns.

One honest caveat: my evidence here is largely qualitative. Retailer conversations, observed footfall, and reported trends from FMCG companies. Published household consumption data with sufficient granularity and recency is hard to come by in India. The direction of the trend feels clear. The precise magnitude is harder to pin down.

A middle lane that actually works — sometimes

Before making the case for polarization, it is worth pausing on a trend that complicates the story.

Uniqlo and Miniso — Japanese and Korean retail chains — have found a growing and loyal customer base among younger, urban Indians over the past few years. Neither is cheap in the way Zudio is cheap. Neither is premium in the way a luxury brand is premium. They sit in the middle, and they are doing well.

What they offer is a specific combination: consistent quality at a price that feels fair. Not the lowest price. Not an aspirational premium. Just reliable value.

Indian FMCG companies have cracked versions of this in the past. Some detergent and personal care brands built large businesses by offering clearly better quality than the cheapest option, without asking consumers to stretch to a premium price. That formula works — but it is operationally very hard to sustain, and it requires genuine product differentiation, not just positioning.

The honest conclusion here is that the middle is not dead. It is just difficult. Companies that can credibly deliver quality at a fair price can survive and grow there. Companies that are merely positioned in the middle — without a real quality advantage — are the ones getting squeezed. The distinction matters for investors.

Why the rich are spending more, and what it tells us

At the other end of the market, something very different is happening. Premium and luxury goods — alcohol, high-end home fittings, luxury cars, watches, premium apartments — are selling well. In some categories, they are selling better than ever.

The explanation is straightforward. Wealth in India has become more concentrated at the top over the past decade. A relatively small number of households has seen very large gains in income and asset values. This group can afford — and now routinely buys — things that were once considered out of reach for all but a handful of Indian consumers.

In volume terms, this group is small. In value terms, it is large enough to move entire categories. A luxury goods business that captures even a modest share of this segment can generate revenues and margins that a mass-market company with ten times the customer base would struggle to match.

This trend is real and it is likely durable, for a simple reason: nothing in the near-term policy or economic outlook suggests a reversal of the wealth concentration that is driving it. Barring a significant redistribution shock — which is not visible on the horizon — the premium end of the market will continue to grow.

The uncomfortable corollary: this trend is a direct product of inequality. The premium boom and the downtrading squeeze are not separate phenomena. They are two consequences of the same underlying dynamic — income growth that has been heavily skewed toward the top. Investors can choose to benefit from this. They should also be clear-eyed about what they are investing in.

The infrastructure problem: same disease, different patient

The tendency to choose the lowest price regardless of quality is not confined to household shopping. It appears to have taken root in how public money gets spent on infrastructure.

Bridge collapses. Roads that develop potholes within months of opening. Transformers that fail soon after installation. These are not one-off accidents. They form a pattern — and the pattern points toward a procurement system that consistently rewards the lowest bid, without adequately pricing in quality, durability, or execution risk.

India's public infrastructure tendering is dominated by L1 — lowest-bidder — frameworks. The political and administrative logic is understandable: it minimizes the appearance of favoritism and is easier to defend against audit objections. But the economic outcome is predictable: contractors win by cutting costs, and quality is often the first casualty.

For investors in construction and infrastructure companies, this creates a specific and underappreciated risk. Companies that depend heavily on public works contracts face perpetual margin pressure, because winning business requires bidding low. Execution risks are elevated because their suppliers are also bidding low. And as public scrutiny of infrastructure quality increases, so does the liability exposure when things fail.

This is not a reason to avoid the sector entirely. Some infrastructure businesses are well-insulated: those with private-sector clients who price for quality, those with long-term annuity concession models, and those offering specialist technology that faces less direct price competition. But the broad category of public-works contractors deserves a harder look than most investors give it.

What this means for investors: Two viable ends, a difficult middle

Let me try to state the investment implications as plainly as possible.

In the consumer space:

The market is splitting. At the mass end, volume and distribution are what matter — brands and platforms that can reach the largest number of price-sensitive buyers efficiently. At the premium end, pricing power and brand credibility are what matter — businesses that serve customers who will pay more for something they believe is genuinely better.

The difficult position is the middle. Not impossible — as Uniqlo and a handful of Indian FMCG brands demonstrate — but hard to sustain without a real quality advantage. Mid-market companies that are positioned in the middle without owning that quality advantage are vulnerable.

A concrete but incomplete shortlist of where to look: mass-market FMCG with strong rural distribution; economy retail formats; budget digital commerce platforms; premium alcohol; high-end home improvement; wealth management and financial services catering to affluent households. This is not a buy list — it is a directional filter.

In the infrastructure space:

Be selective. Avoid companies whose revenues are overwhelmingly dependent on government construction contracts won through lowest-bid tendering. Prefer companies with private-sector client exposure, annuity-based revenue models, or genuine technological differentiation. The risk in public-works contractors is not obvious from their order books — it shows up in margins, execution delays, and the occasional catastrophic quality failure.

The caveat

The downtrading evidence is qualitative. Retailer conversations and observed footfall are useful signals, but they are not a substitute for hard data. The direction looks right. The scale is uncertain.

The bifurcation thesis has counter-examples. Several respected Indian consumer companies — Titan, Havells, Asian Paints, Marico — have built enduring businesses in spaces that are neither pure mass nor pure luxury. They complicate the avoid-the-middle argument and deserve acknowledgment.

The infrastructure investment call needs refinement. The sector is large and varied. Painting it with a single brush is too broad. The caution applies most directly to L1-driven government contractors. It does not apply equally to the whole sector.

None of these caveats invalidates the central observation. But they are a reminder that what follows from field observation and qualitative reasoning is a hypothesis to investigate, not a conclusion to act on without further work. 

Exercise caution in the peace trade

Markets are growing complacent

With each passing day, global markets appear to be becoming increasingly sanguine about the situation in West Asia. A growing chorus of analysts and business leaders are expressing confidence that the conflict will wind down soon, and that energy markets will revert to their pre-war equilibrium within a matter of months. Some have gone further, predicting that energy prices could settle at materially lower levels than those that prevailed before hostilities began — a scenario premised on the easing of American sanctions on Iranian and Russian crude, alongside a ramping up of production by Venezuela and the UAE, which now operates outside its OPEC quota constraint.

I would suggest investors approach this “peace trade” with considerably more caution than current sentiment suggests. The probability is high that markets have already largely discounted the peace dividend — including the normalization of commercial traffic through the Strait of Hormuz. Positioning for a windfall that is already in the price is not a trade; it is a hope.

Energy prices will not snap back instantly

Even if the Strait of Hormuz were to reopen tomorrow, a return to pre-conflict energy price levels is far from assured. The physical infrastructure damaged during the conflict may take several months to restore to operational pre-war capacity. Beyond the supply mechanics, the fiscal break-even levels for crude oil in several Gulf states — notably Saudi Arabia and Bahrain — may have risen materially during the conflict period, driven by expanded defence and welfare commitments. Producers at elevated break-evens have little incentive to flood the market.

For the world’s major energy importers — concentrated in Asia and Europe — a sustained period of higher energy costs leaves a lasting imprint on the terms of trade, keeping inflationary pressures elevated long after a formal truce is announced. The inflationary overhang, compounded by the fiscal pressures that governments have taken on to cushion the economic blows of war, has pushed the timeline for meaningful policy rate cuts further into the future.

Bond markets are, accordingly, struggling. A truce in West Asia is unlikely to offer them immediate relief. For India in particular, the case for near-term rate hikes — rather than cuts — may in fact strengthen in the months following any ceasefire, as the rupee finds its new level and imported inflation feeds through domestic price indices.

Equities: Resilience has limited the upside

The behavior of risk assets throughout the conflict has been, in a word, surprising. Equity investors’ appetite for risk has held up with a tenacity that few would have predicted when hostilities began. That resilience is admirable from a behavioral standpoint, but it carries a practical cost: it has substantially compressed the room available for a dramatic post-truce rebound in equities and other higher-risk instruments.

In my view, returns in the post-truce environment will be primarily a function of earnings growth rather than multiple expansion. A broad macro trade — the kind of re-rating that follows a genuine risk-off episode — is unlikely to materialize in the near term. The case for an immediate PE re-rating is simply not there.

The more productive tactical opportunity is likely to emerge from sector rotation rather than from an index-level trade. Sectors that have been beaten down during the conflict — IT services and FMCG chief among them — may outperform the currently favored themes: power infrastructure, data centers, and defence. However, this rotation trade is not without risk: IT services faces a structural headwind from AI-driven efficiency pressures on technology budgets, while FMCG grapples with volume growth in a consumer environment compressed by negative real wages.

India’s problems run deeper than the war

This brings me to the more uncomfortable argument. A meaningful segment of investors appears to believe that India’s market difficulties are substantially, if not primarily, a product of the West Asia conflict, and that resolution of that conflict will provide a correspondingly powerful tailwind. I think that view is mistaken, and potentially costly.

India is contending with a multitude of structural problems that will not dissolve with a ceasefire. On the macroeconomic front: the current account deficit has widened under the weight of elevated energy import costs; net FDI has turned negative; FII outflows have been persistent and large over multiple years; the rupee has been among the worst-performing major currencies; and the government’s fiscal space is contracting simultaneously from multiple directions — expanded defence spending, subsidy commitments, and weakening tax revenue in a slowing economy.

The demographic picture adds a longer-horizon concern. India’s Total Fertility Rate has remained below the replacement threshold of 2.1 for five consecutive years, standing at 1.9 in 2024. The urban TFR has fallen to 1.5 — a level comparable to ageing Western European societies. The window for harvesting a demographic dividend, in the economically dominant urban half of the country, has effectively already closed. This is not a cyclical problem that a peace settlement will address.

The climate emergency compounds these pressures. In April and May 2026, all fifty of the world’s hottest cities were located within India on multiple days. Agricultural output is under threat. Power grids are strained. Water scarcity has intensified. These are not episodic shocks; they are structural forces that will weigh on productivity, public finances, and social stability for the foreseeable future — independent of what happens in the Strait of Hormuz.

There are governance and institutional dimensions as well. Investor confidence in the consistency of regulatory enforcement, the independence of the judiciary, and the quality of economic policymaking has been eroding. Corporate India, despite tripling net profits between FY21 and FY25, has cut private investment as a share of GDP to a twenty-year low, with promoters opting to accumulate cash, establish family offices, and increase overseas allocations rather than deploy capital productively at home. This is not the behavior of a business community that is broadly optimistic about the domestic investment environment.

Conclusion: Price in the complexity

The peace trade is a legitimate market theme, and a ceasefire in West Asia would unquestionably remove a source of uncertainty that has weighed on global sentiment. But investors who expect that outcome to resolve India’s investment challenges are, in my view, underestimating the complexity of what lies underneath.

The macro headwinds are structural, not cyclical. The demographic dividend is narrowing. The climate crisis is intensifying. Institutional confidence is fragile. Corporate investment remains suppressed. A truce will not, by itself, resolve any of these. Position size your peace trade accordingly.

और भी दुख हैं ज़माने में मोहब्बत के सिवा

राहतें और भी हैं वस्ल की राहत के सिवा

— Faiz Ahmed Faiz

Why are markets in a state of disbelief?

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

Rein Your Horses