Believing in India

India’s economic engine suffered a loss of power in 2025. It led to earnings downgrades, investor outflows and currency weakness. An unexpected geopolitical headwind, combined with the allure of more AI-centric markets, further accelerated a shift in global capital allocation and investor sentiment. Approximately $18 billion was withdrawn from India’s equity market in 2025, which materially contributed to the market’s underperformance relative to its peers.

From our perspective, 2025 marked more of a recalibration in confidence than a structural impairment of India’s long-term investment thesis. That is not to dismiss the challenges in the near-term landscape. However, we believe the strategic case for a diversified allocation to India remains intact.

Geopolitics

At the beginning of 2025 and the start of Donald Trump’s second presidential term, global markets were anxious over the prospect of a potential new wave of U.S. tariffs. India was initially viewed as an unlikely target given its relatively neutral position in global politics and positive relations with the U.S. Investors were therefore caught off guard when the two countries failed to reach a trade agreement and the U.S. hiked export duties on India. Equally unexpected was the subsequent announcement of a trade deal and a reversal of those tariffs. While U.S. trade policy has entered a new chapter of uncertainty prompted by the Supreme Court’s decision to strike down reciprocal U.S. duties, we believe some reassurance can be drawn from the clear improvement in bilateral relations between India and the U.S.

One significant benefit of improving geopolitical relations, in our view, will be an amelioration in sentiment among both overseas investors and international businesses. As U.S.-India relations become more nominalized, India’s appeal as a destination for capital investment and operational relocation should be strengthened. This in turn could provide a stabilizing underpinning for the rupee.

More broadly, while tariff volatility should be monitored, India is a domestically driven economy and the impact of trade duties on its growth and on its companies should not be overstated. The country’s consumer markets, financial sector and evolving industrial and manufacturing bases will continue to expand, in our view, amid changes and developments in international trade conditions.

The economy

Turning to the economy, nominal GDP growth slowed in 2025 after several years of double-digit expansion. Pent-up post-Covid consumer demand waned as adverse weather events in 2024 added to inflationary pressures. Two additional variables compounded the slowdown: India’s central bank maintained a policy of tight liquidity, and the government tempered its public CapEx agenda. This softening in growth fed quickly into earnings downgrades and negative investor sentiment.

After tax cuts and an aggressive cycle of interest rate reductions last year, we think the economy will start to improve, gaining traction in the second half of 2026 and into 2027. Encouragingly, there are some early signs of improvement. Rising rural wages, for example, supported by favorable agricultural dynamics, government support mechanisms and lower interest rates, are translating into stronger consumption. In the immediate term, both the economy and the markets face headwinds amid concerns over rising global oil prices and disruption to Middle East gas and oil shipments resulting from the war in Iran.

Structural drivers remain intact

Thanks to public spending and pro-business reforms, India’s manufacturing industry has expanded and progressed in recent decades, alongside continued strength in established sectors like pharmaceuticals and information technology (IT). More recently, however, investment activity has narrowed, increasingly shaped by government incentives and policies—including in electronics manufacturing and parts of the power sector. Outside these areas, CapEx has been weaker.

As economic growth strengthens, we believe the environment for private and public CapEx will improve. A recovery in investment would directly benefit India’s long-term growth engines: its young demographic, its industrial capacity, and its entrepreneurial and skilled urban labor force.

AI: a headwind or a tailwind?

One secular area of long-term growth potential, in our view, is artificial intelligence (AI). In the near term, it may be a source of disruption as automation and generative technologies expand into India’s significant IT and business consulting services bringing new efficiencies and potentially eroding margins. Over time, however, we believe AI can support growth in these sectors and potentially facilitate a new competitive edge.

The government is also demonstrating a will for India to be part of the global AI infrastructure buildout. In its recent budget, it announced tax incentives to attract both domestic and overseas investment in data centers. India has drawn significant AI-related investment from companies including Microsoft and Alphabet. The government estimates it will attract $200 billion in AI capital over the next two years.¹

We believe AI infrastructure, alongside the electronics manufacturing ecosystem, including printed circuit board (PCB) and semi-conductor wafer production, could become a meaningful growth component in the years ahead.

Why India matters

India is among the world’s largest economies and has the world’s largest working population. It has established business sectors and its production hubs make it a compelling destination for inward foreign investment, in our view. India is also an internally powered economy with a vast consumer market. For these reasons, we believe it offers investors a powerful and differentiated growth opportunity in emerging markets.

Near term, volatility in Indian equities may remain elevated. Developments related to the Iran conflict may generate economic challenges and the breadth of the equity market itself has narrowed with weakness particularly pronounced in small and mid cap segments as various sources of capital—including high net worth and retail investors—have withdrawn funds. We believe a sustained recovery in investor sentiment will likely require stabilization in the rupee and greater clarity over earnings trajectories.

Overall, while conditions remain challenging in some areas, we take reassurance from our view that the weakness in India’s equity market is largely tied to short-term headwinds and sentiment-driven factors unrelated to India’s structural investment case. We anticipate a gradual recovery in private CapEx alongside a broader pickup in domestic consumption. India is a resilient economy and, in our view, will continue to offer attractive, differentiated exposure relative to more export-dependent equity markets.

¹As of Jan. 31, 2026, accounts managed by Matthews had no holdings in Alphabet and Microsoft.