India’s Market Paradox: Why Resilience and Risk Coexist
Indian markets are presenting a fascinating, and somewhat unsettling, picture. Despite a fundamentally strong macroeconomic environment, recent months have seen jarring disconnects – a weakening rupee, substantial foreign institutional investor (FII) outflows, and a stark underperformance compared to global peers. This isn’t the typical behavior expected during periods of economic strength. Let’s unpack what’s happening and what it means for the year ahead.
The Rupee’s Hidden Weakness
While a 4.5% depreciation of the Indian rupee against the US dollar this year might seem moderate, it’s a deceptive figure. The dollar itself has weakened significantly – nearly 10% – meaning the rupee’s underperformance against other currencies is far more pronounced, falling 14-15%. Against the Euro, the depreciation exceeds 16%, placing India among the worst-performing currencies globally. This isn’t simply about dollar strength; it’s about relative weakness in the rupee.
Unprecedented FII Sell-Off: Beyond the Headlines
The reported $18-19 billion in FII selling for 2025 doesn’t tell the whole story. Consider this: that figure comes after $8 billion in primary market inflows and on top of $18 billion in selling during the final two months of last year. Over the past 15 months, FIIs have offloaded over $44 billion in Indian secondary markets – a scale rarely witnessed in Indian market history. This sustained pressure is a major factor driving market anxieties.
A Two-Tiered Market: Nifty Strength, Broader Market Carnage
The Nifty and Sensex indices hovering near all-time highs create a misleading impression of overall market health. Beneath the surface, nearly 50% of broader market stocks have fallen 40-50%, some reverting to 2023 levels. Furthermore, while the Nifty has delivered over 9% returns in rupee terms, dollar returns are in the low single digits. Contrast this with markets like Korea, which have surged nearly 80% in dollar terms, fueled by AI-related investments. This divergence highlights a significant disconnect within the Indian market.
Bond Market Anomaly: Rate Cuts, Rising Yields
The situation in the bond market is equally perplexing. Despite the Reserve Bank of India (RBI) cutting rates by 125 basis points and injecting liquidity through various measures, the 10-year G-sec yield has climbed back to 6.6-6.7%, nearly where it started before the easing cycle. This stubborn yield increase, driven by currency weakness and FPI selling in bond markets, adds another layer of complexity to the current market dynamics.
Is This a Fundamental Crisis or a Temporary Dislocation?
Despite these concerning data points, India’s macroeconomic fundamentals remain remarkably robust. Twin deficits are manageable, forex reserves are healthy, GDP growth is strong, and inflation is under control. Moreover, there’s a renewed momentum in economic reforms.
The Reform Push: Turning Challenges into Opportunities
The current administration has unleashed a series of significant policy measures, including GST 2.0 reforms, new labor codes, 100% FDI in insurance, opening up the nuclear power sector to private investment, and aggressive pursuit of Free Trade Agreements (FTAs). Whether driven by stalled US trade negotiations or a genuine commitment to structural reform, this policy drive has the potential to significantly enhance India’s long-term growth prospects.
Why the Divide Between ‘Math’ and ‘Mood’?
The disconnect between positive fundamentals (‘math’) and negative market sentiment (‘mood’) can be traced back to the September 2024 peak. A slowdown in economic growth due to election-related capex pauses, heavy monsoons, and tight liquidity initially went unnoticed. However, the Q2 earnings season served as a reality check, particularly given elevated valuations. This triggered a sharp reaction from FIIs, who sold over $18 billion in October-November 2024. While domestic flows provided some support, relentless FII selling, coupled with a shift in global capital towards AI-related investments and delays in the India-US trade deal, created a panic in the rupee and a vicious cycle of fear.
Looking Ahead: Potential Catalysts for 2026
Several factors could shape the market landscape in the coming year.
The AI Trade Reset
While the AI boom isn’t likely to collapse, incremental capital flows into AI are expected to slow in 2026 due to valuation concerns. This could benefit India, which is increasingly viewed as an AI diversification theme.
Rupee Stabilization and Potential Appreciation
On a Real Effective Exchange Rate (REER) basis, the rupee is currently undervalued at 98, compared to its long-term average of 102-103. Having depreciated from levels above 108 a year ago, the worst of the depreciation cycle appears to be over, with potential for 2-3% appreciation. A stabilizing or strengthening rupee could be a powerful catalyst for FII return.
FII Re-engagement and Value-Momentum Blend
With FIIs having already sold aggressively and domestic flows remaining resilient, a return of FII flows could reignite market momentum. However, 2026 is likely to be a blend of value and momentum, rather than a one-way rally.
Opportunities in a Corrected Market
With nearly half of broader market stocks down 40-50%, opportunities are abundant across sectors like renewables, auto ancillaries, precision engineering, and pharma/CDMO. Disciplined bottom-up stock picking will be crucial.
FAQ
Q: What is REER and why is it important?
A: REER (Real Effective Exchange Rate) measures a currency’s value against a weighted average of its trading partners’ currencies, adjusted for inflation. It indicates whether a currency is undervalued or overvalued.
Q: What are CDMOs?
A: CDMOs (Contract Development and Manufacturing Organizations) are companies that provide outsourced development and manufacturing services to the pharmaceutical and biotechnology industries.
Q: Is now a good time to invest in Indian markets?
A: While risks remain, the current market correction presents opportunities for long-term investors. Careful stock selection and a focus on fundamentals are essential.
What are your thoughts on the Indian market outlook? Share your insights in the comments below!
