India EM Comeback: 2025 Underperformance Sets Up 2026 Rebound

By Kanishk Devbangia, NISM Series XV Certified Research Analyst (NISM-202300182946)

1. What Are Emerging Markets (EM)?

Emerging Markets are countries whose economies are growing and developing rapidly, but have not yet reached the full maturity of developed economies like the United States, Germany, or Japan. They are somewhere in between — more advanced than frontier markets, but not quite at the level of fully developed nations.

2. India's Place in the Emerging Markets Universe

India is one of the largest and most watched emerging markets globally. Here is why it occupies such a central role in the EM conversation.

India's Weight in Global EM Indices

Index providers like MSCI have steadily increased India's weightage in their Emerging Market indices over the past decade. This matters because global funds that track EM indices automatically allocate a portion of their money to India. As India's weightage grows, more global capital flows in passively — independent of active investment decisions.

3. What Happened in 2025: The Underperformance Explained

The Setup Coming into 2025

India had a spectacular run between 2020 and 2024. Post-pandemic recovery, infrastructure spending by the government, a booming startup ecosystem, and strong corporate earnings drove Indian equities to historically high valuations. The Nifty 50 hit multiple record highs during this period.

However, when valuations rise faster than underlying earnings, a correction becomes mathematically inevitable. By late 2024 and into 2025, several factors combined to cool the market down.

Key Reasons India Underperformed EM Peers in 2025

A. Valuation Correction

India's price-to-earnings (P/E) ratios — a standard measure of how expensive a market is relative to company earnings — were trading at a significant premium compared to other EM peers like China, Brazil, and Indonesia. When global money managers rebalanced their portfolios, India's expensive valuations made it a natural candidate for profit-booking.

B. Foreign Institutional Investor (FII) Outflows

Foreign Institutional Investors (FIIs) are large global funds — pension funds, hedge funds, sovereign wealth funds — that invest in Indian markets. When global interest rates remained elevated (especially in the US), many FIIs pulled money out of riskier emerging markets, including India, and parked it in safer US assets that were offering attractive returns. This outflow of FII money created selling pressure on Indian indices.

C. A Stronger US Dollar

When the US dollar strengthens, emerging market currencies — including the Indian Rupee — tend to weaken. A weaker Rupee makes Indian assets less attractive to dollar-based foreign investors, because currency depreciation erodes returns when converted back to dollars. The rupee came under pressure through parts of 2025, adding to the headwinds.

D. Retail Investor Profit-Taking and SIP Slowdown

India saw an explosion in retail participation through Systematic Investment Plans (SIPs) in the years after COVID. However, as markets corrected and sentiment turned cautious, some retail investors paused or reduced their SIP contributions. This reduced the steady inflow of domestic money that had previously provided market support.

4. Retail Participation: India's Unique Domestic Story

One of India's most distinctive features as an equity market is the rapid growth of domestic retail participation — ordinary Indians investing in stocks and mutual funds in large numbers for the first time.

The SIP Revolution

India's mutual fund industry saw its monthly SIP inflows grow from around ₹8,000 crore per month in 2020 to over ₹20,000 crore per month by 2024. This represents millions of middle-class Indians — teachers, doctors, small business owners, salaried employees — systematically investing in equity markets, often for the first time in their families' histories.

Why Retail Participation Matters

Domestic retail flows provide stability to Indian markets. When FIIs sell, DIIs — largely funded by retail SIP money — can absorb the selling pressure. The more robust domestic participation is, the less vulnerable India becomes to global capital flow volatility.

What Happened in 2025 to Retail Flows?

As markets corrected and returns were muted, some first-time investors panicked and either paused SIPs or redeemed units. This is a common behavioral pattern — investors tend to be most enthusiastic at market tops and most fearful at market bottoms. However, the underlying trend of growing retail financial literacy in India remains structurally intact.

5. HNI Re-Entry: What It Signals and Why It Matters

Who Are HNIs in the Indian Context?

In India, HNIs are typically classified as individuals or family offices with investable assets above ₹5 crore. This category includes successful business owners, senior corporate executives, real estate entrepreneurs who have monetised assets, and professionals who have accumulated significant wealth over decades.

How Do HNIs Invest?

Unlike retail investors who primarily use mutual funds and SIPs, HNIs have access to a broader range of instruments:

• Portfolio Management Services (PMS) — where a fund manager manages a customised portfolio directly.

• Alternative Investment Funds (AIFs) — more sophisticated structures, often with higher minimum investments.

• Direct equity — buying shares directly based on research and personal conviction.

• Structured products — instruments with customised risk-return profiles.

What Does 'Re-Entry Window Forming' Mean?

When analysts and market observers talk about an 'HNI re-entry window forming,' they are observing that HNIs — who may have moved to cash or fixed-income instruments during the peak and correction phase — are beginning to show interest in re-entering equity markets.

This is typically triggered by a combination of factors: valuations becoming more reasonable, market sentiment bottoming out, and macroeconomic signals improving. HNIs tend to enter markets thoughtfully and ahead of the broader crowd, which is why their re-entry activity is considered a meaningful signal.

6. Macroeconomic Signals: What the Data Is Saying for 2026

Let us look at the broader macro landscape that forms the backdrop for any discussion of India's potential rebound in 2026.

India's GDP Growth Trajectory

India's real GDP growth has remained among the strongest of major economies globally. Estimates for 2025-26 from institutions like the IMF, World Bank, and RBI have generally placed India's growth in the 6.5–7% range. This level of economic growth — sustained over multiple years — is the bedrock of the corporate earnings story that ultimately drives equity markets.

Inflation and the RBI's Monetary Policy

The Reserve Bank of India (RBI) — India's central bank — manages monetary policy. After a period of elevated global inflation, India's CPI (Consumer Price Index) inflation has trended toward more manageable levels. A more benign inflation environment gives the RBI room to potentially ease interest rates, which is generally positive for equity valuations (lower rates make future earnings more valuable today).

Government Capital Expenditure (CapEx)

The Indian government has maintained an aggressive infrastructure spending program — on roads, railways, ports, airports, and digital infrastructure. This government CapEx creates demand across multiple sectors, supports employment, and lays the groundwork for private sector investment. It is a structural positive that directly feeds into corporate earnings growth.

Currency Stabilisation

After the Rupee experienced depreciation pressure in 2024-25, a stabilisation of the currency would reduce one layer of risk for foreign investors. India's forex reserves — which have been maintained at historically comfortable levels — provide a buffer against excessive currency volatility.

Disclaimer:

This is written for educational and informational purposes only. Nothing here constitutes investment advice or a recommendation to buy or sell securities. All data is sourced from publicly available information. Investments in securities markets are subject to market risks — please read all offer documents carefully before investing.