As one can infer, the reference is of course to various shocks in the market starting from crash in Rupee to massive FII sell-off and further on to unimaginable underperformance of Indian markets against global markets. Let us dive in.
Let us start with the shock in the currency. At first glance, the Indian rupee appears to be down a modest 4.5% odd against the US dollar this calendar year. But this headline number is misleading. The US dollar itself has weakened by nearly 10% this year, meaning most global currencies have moved up sharply against it. This means, Rupee’s underperformance against other currencies is quite stark at 14 to 15% level. For example, against the Euro, the rupee has depreciated by over 16% this year, an extraordinary move and among the worst globally.
Then comes the shock of unprecedented FII selling. Here again, the headline number of 18-19 billion dollars for calendar year 2025 doesn’t reveal the full story. This number coming on the back of $8 billion of primary market inflows this year and on top of 18 billion dollars of selling in Oct and Nov last year means that the FIIs pressed sale of over 44Bn dollars over the last 15 months in the secondary markets. That is massive by any standards – a scale rarely seen in Indian market history.
Carnage in the broader markets is the next one. While the Nifty and Sensex are only few points away from all-time highs, this masks massive carnage in the broader markets. Nearly 50% of broader market stocks are down 40–50%, with many retracting back to 2023 levels. Further, despite Nifty delivering 9%+ returns in rupee terms this year, returns in dollar terms are in low single digit. Meanwhile, global markets, both developed and emerging, have delivered way beyond 20% returns in most of the cases, with markets like Korea up nearly 80% in dollar terms, driven largely by AI-related flows. The Indian markets had not witnessed this level of shocking underperformance any time historically, that too in a globally benign times except in periods like 2013 when the domestic economy was in deep stress because of localized macro challenges.
The shocks are not only limited to Rupee and stocks. They have spilled over to bonds as well. Otherwise, how would one explain this – despite the RBI cutting rates by 125 bps since February 2025, injecting liquidity month after month (via OMO etc), and reducing CRR, the 10-year G-sec yield has climbed back to 6.6 – 6.7%, almost where it stood before the easing cycle began. This stubborn and unyielding behaviour of the G-sec yield – driven by the currency weakness and FPI selling in bond markets – is no way a lesser shock.
With listing of the shocks out of the way, here is this important question now – Is the macro under such a severe stress as these data points would suggest or these are irrational dislocation?
Indian macro as measured by twin deficits, forex reserves, GDP growth, inflation and interest rate outlook etc. is not only one of the shining spots in the global economy, but also one of the rare environments where visible reform momentum is back with a rigour.
In this context, it is hard to miss the newfound urgency in the policymaking (reforms) from this administration. Critics might claim that it is out of pressure from stalled US trade deal. Irrespective of that, the underlying drive from this administration to convert this tariff challenge into an opportunity for accelerated reforms can greatly enhance the structural growth potential for the economy. Listed below are the partial list of key policy measures that have been unleashed by the Govt.
- GST 2.0 reforms
- New Labor codes
- 100% FDI in insurance
- Opening up of nuclear power to private sector
- New Coal Auctioning Bill
- Oil & gas exploration reforms
- Aggressive push on FTAs
It will be a surprise if this reform momentum does not intensify further in the upcoming budget.
In addition to the positives from the reforms, market is heading into 2026 with additional tailwinds in the form of earnings acceleration in FY27 amid normalization in valuation with Nifty multiple cooling off to historic averages.
Given this, it is logical to wonder, why there is such a deep divide between Math (valuations, earnings, macros) and Mood (flows, fear)?
To answer this, it is important to step back and look at how markets evolved since the September 2024 peak.
Sometime during Sept quarter last year, economic growth slowed due to election-related capex pauses, heavy monsoons, and tight liquidity. Markets initially ignored this, but the Q2 earnings season triggered a reality check, especially given elevated valuations. FIIs reacted sharply to this by resorting to selling over $18 billion in Oct–Nov 2024. Despite this, Indian markets largely held up on the support from domestic flows. But towards the year end, relentless FII selling caused by aggressive allocation to AI trade coming amid delay in India-US trade deal triggered a panic in Rupee which in turn set off a vicious cycle of fear – where fundamentals were pushed to the back seat and risk assets were sold off indiscriminately, especially in small and midcaps leading to negative mood overtaking math unjustifiably though.
This brings us to where we are now.
Looking ahead, what should investors expect? In addition to comfort factors such as normalization of valuation and visibility of earning acceleration etc, there are few more additional tailwinds that could shape the markets in the coming year.
First, the potential AI trade reset. While AI may not collapse, incremental capital flows into AI are likely to slow in 2026 due to valuation concerns. A cooling of the AI trade would benefit India as India is perceived as an AI diversification theme.
Peaking of Rupee depreciating cycle is the next and critical one. On a REER (Real Effective Exchange Rate) basis, the rupee is currently undervalued at 98 level versus its long-term average of 102–103. From levels above 108 a year ago, this suggests depreciation is largely behind us, with scope for 2–3% appreciation.
A stabilising or strengthening rupee could act as a powerful catalyst for FIIs return. More so, if the growing optimism around a US–India bilateral trade agreement by early 2026 materializes.
With FIIs having already sold aggressively and domestic flows remaining resilient, a return of FII flows could reignite the momentum. However, unlike the one-way rally of 2024, 2026 is likely to be a blend of value and momentum.
With nearly half of broader market stocks down 40–50%, opportunities are abundant across sectors – renewables, auto ancillaries, precision engineering, pharma/CDMO, and more. No dearth of opportunities across the spectrum for disciplined bottom-up stock picking. Will 2026 be the year when Math overtakes Mood? Only time will tell!
