MUMBAI: India’s benchmark equity index may struggle to attract foreign institutional investor (FII) money as the Nifty 50 remains heavily skewed towards banking and information technology (IT) stocks, sectors facing slowing growth and structural disruption from artificial intelligence (AI), according to Manish Sonthalia, chief investment officer at Emkay Investment Managers.
The IT services business model is getting disrupted through AI, Sonthalia said in an interview with Mint, adding that banking system growth is likely to remain around 10-12%.
Current Nifty 50 valuations of 22-23x earnings, that may not be attractive enough for FIIs, he said, arguing that domestic institutional investors (DIIs) may have to continue supporting Indian markets in the near term.
Edited excerpts:
DIIs have pumped ₹3.5 trillion into equities as of May, equivalent to 40% of last year’s inflows in just four months. Will the optimism sustain, and do you see excessive DII flows as a concern?
There is enough maturity among investors. If some old investors are leaving and closing their SIPs (systematic investment plans), we are seeing some new investors coming in. Interest rates have also been a reason why we have seen so much optimism in markets. With fixed deposits currently offering post-tax returns of around 5%, against 5% inflation, equities remain attractive. But if deposit rates rise to 8%, investors could shift from equity to zero-risk debt instruments.
For FIIs, the dollar returns are not that great with the rupee depreciating. In such a scenario, I do not really see FIIs coming to Indian markets in the near future so all the heavy lifting of returns has to happen from domestic investors. But do we require foreign capital? Absolutely yes. We cannot aspire to grow at 8-9% GDP without foreign capital. With domestic flows we may grow only at 5-6% GDP.
How do you see rupee at 96 to a dollar impacting foreign flows? What macro risks do you see?
If the war doesn’t get resolved by June and crude prices remain elevated, India, being a net importer of oil, will have to pay more dollars for energy imports. At the same time, India's exports, primarily comprising software, are facing headwinds because of AI, so we are in a double whammy sort of situation.
We are currently sitting on oil inventories but if the war extends beyond June, it could trigger a sharp energy supply shock, pushing oil prices higher and leaving India vulnerable on the current account and currency front. The central bank is aggressively defending the rupee, but much depends on a diplomatic resolution of the war, with the rupee’s fair value estimated at 91–92 if the conflict eases by June-end.
A stronger rupee could trigger FII short covering and boost markets. For foreign investors, even if Indian stocks remain flat, a rupee move from ₹91 to ₹96 translates into a 5-6% loss in dollar terms. If the rupee starts appreciating again, FIIs could benefit from currency gains.
Korea and Taiwan saw huge outflows recently. Do you see some of that money coming to India?
As of now, India’s macros remain under pressure. India is already trading at 22–23x its earnings and the Nifty 50 index is heavy on banks and IT. The IT services business model is getting disrupted by AI.
Banking system growth is going to be 10–12%, so for a 10-12% sort of index growth you’re paying 22x — roughly 2 PEG (price/earnings-to-growth ratio). Is that good enough for FIIs? Maybe not. Hence we should not bet big on FII flows in India. The heavy lifting will have to come from domestic investors.
What is your view on Indian IT companies?
The IT services business model has been disrupted massively. Dollar revenue growth expectations for IT companies have fallen from 8-10% earlier to low single digits. While rupee depreciation may still help companies report 7-8% top-line growth in rupee terms, high cost inflation is preventing margin expansion.
The sector may, at best, act as a stabilizer rather than deliver strong growth returns. Any near-term rally is likely to be a temporary “dead cat bounce” unless Indian IT firms significantly reinvent their business models and step up AI investments, where they are currently behind the curve.
Will we see the weight of IT further coming down in the Nifty 50?
The weight of IT stocks in the Nifty 50 has already fallen sharply from 12-13% earlier to around 6.5-7%, and this will come down further. FIIs hold their largest positions in banks and IT, while domestic mutual funds are already heavily invested in large private banks.
Plus, mutual funds cannot have more than a 10% allocation in a single stock. So they cannot do much incremental buying. Even if FIIs continue selling these stocks, how much more can DIIs buy if they already own them near the maximum limit?
Are there any sectors where you hold a contrarian view?
As India gradually builds AI infrastructure, sectors currently treated as commodities such as aluminium, copper and steel could emerge as critical raw materials for the AI ecosystem.
Critical minerals may no longer be viewed as plain commodity businesses over the next 5-10 years, but rather as strategic assets essential for AI infrastructure, leading to higher valuation multiples.
Any sector you like?
Hotels, which are facing headwinds from higher crude prices, could emerge as strong long-term opportunities over the next 3-4 years. The sector is fundamentally backed by a simple and durable demand driver: people need a place to stay while travelling.
With millions of Indians travelling daily by air, rail and road, demand for accommodation is structurally rising across categories ranging from dharamshalas and budget stays to branded hotels. Despite being a $4 trillion economy, India has only around 350,000 branded hotel rooms, while supply growth remains naturally constrained because room additions typically cannot exceed around 5% annually.
Even though the hotel business requires high upfront investment, it benefits from strong operating leverage over time, allowing margins and profits to expand as occupancy rises.
At the same time, the government is pushing tourism as a key growth driver, airports are expanding across the country and domestic travel is increasing rapidly.