Economic outlook for FY26 looks better with sharp rebound in govt spending, reduction in inflation: Geojit's Vinod Nair

The Indian stock market closed FY25 with a subdued performance. The broad market delivered a modest return of 5.35%, a significant decline from the exceptional 39% recorded in FY24. FY25 downturn accelerated in the latter half of the fiscal year, driven by a sharp decline in earnings growth.

In FY24, corporate earnings in India exhibited robust expansion, exceeding 20%, which contributed to the market's strong performance. During FY25 initial period, expectations remained optimistic underpinned by a stable domestic economy. For example, RBI had projected 7.2% real GDP growth in its June 2024 policy review. However, actual economic conditions proved less favourable, as weak capital expenditure, particularly in a year dominated by elections, weighed on growth prospects. In FY26, India witnessed 10 elections, including the national election, which led to restrictions on new and ongoing government capital and revenue expenditures. Additionally, the rural economy suffered from the adverse effects of heatwave, an uneven monsoon, and persistently high inflation, which weighed heavily on the agriculture and allied sectors.

Declining earnings triggered substantial selling by Foreign Institutional Investors (FIIs) from September onward, as Q2 results indicated a modest 5% earnings growth for H1FY25—far below the market’s expectation of 16% EPS growth for FY25. At that time, India was trading at a premium valuation of 21.3x one-year forward P/E. FII started to book profits and shift funds to other EMs like China, which was very cheap at 10x P/E, and to safer developed markets like the US & Europe. Meanwhile, the US was still growing well, and its domestic financial market was demanding dollar routing back to the economy as per the quantitative tightening measure.

FII selling accelerated as India struggled to justify its premium valuation. The trend further deepened between January and March as domestic inflows weakened too due to a sustained decline in portfolio values, driven by downturns in both domestic and global markets. By then, global investor sentiment had turned cautious amid uncertainties surrounding Trumponomics. The US market sell-off increased recently, S&P 500 fell by 10% as tariff bomb shelves intensifying, which is feared to slow the US and global economy.

The late introduction of a 25% tariff on car & parts imports is likely to affect key players like Japan, Korea and Germany. For Indian component players for which the North American market is a high business mix, they can lose ground in the long-term. However, ongoing discussions between U.S. and Indian officials to finalize a bilateral trade agreement may help mitigate the adverse effects of these tariffs. Further, trade uncertainty is also weighing on Indian pharmaceutical stocks, as the industry remains a key supplier to the U.S. market and faces potential risks from reciprocal tariffs set to take effect on April 2.

For FY26 the domestic economic outlook appears better with a sharp rebound in domestic government spending, a reduction in inflation and a drop-in interest rate. High-frequency monthly data reflects rising demand across both rural and urban markets. This trend is expected to continue as India remains more reliant on domestic consumption than exports reducing tariff effect. With increasing domestic demand and moderating inflation, corporate earnings are projected to grow toward the long-term average of 15% in FY26-27, up from the estimated 7% in FY25.

While FY25 ends on a muted note, FY26 appears more promising, as the key challenges are largely factored in. The Indian broad market has undergone a 20% correction, effectively pricing in these challenges. Subsequently, India’s valuation is expected to improve, with the stock market likely to perform better in the first half of FY26 compared to the latter half of FY25. Q4FY25 results to be announced from next week will provide the leads to FY26 performance.

The author, Vinod Nair is Head of Research at Geojit Financial Services.

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