India’s continued conundrum for value investors

After several years of exceptional equity market performance, India’s long rally has given way to a period of notable underperformance. Once among the strongest emerging markets, India has recently recorded its weakest relative year since the mid-1990s. The reversal reflects a mix of economic, structural and valuation factors.

Between October 2022 and September 2024, India’s equity market rose 56 per cent, outperforming the MSCI Emerging Markets (EM) Index by 10 per cent. However, in the subsequent 12 months, Indian equities have declined by more than 11 per cent in US dollar terms, while the EM Index gained 18 per cent. This represented India’s worst year of underperformance since 1996, and means that over three years, India has underperformed EM by 21 per cent.

Despite market weakness, India’s economic performance has remained resilient. Prime Minister Narendra Modi secured a third term in the 2024 general election, extending a period of political and policy stability.

On the back of this, real GDP growth was 7.6 per cent in 2023 and 9.2 per cent in 2024, putting India on track to become the world’s third-largest economy within a decade.

Inflation has trended lower, while budget and current account deficits have remained contained. Institutions have generally managed risks effectively, though the central bank has faced criticism for excessive caution.

High interest rates and tighter rules on unsecured lending were blamed for softer consumption and earnings growth in late 2024. Even so, India’s macroeconomic performance has remained impressive compared to global peers.

Domestic bias 

A major shift has occurred in the composition of market participation, with domestic investors emerging as a dominant force. Long-term equity returns have encouraged households to move away from traditional preferences for real estate, gold, and deposits.

Domestic institutional investment in equities has nearly tripled since 2023, while regular contributions to mutual funds through Systematic Investment Plans (SIPs) have broadened participation. These flows have helped offset foreign outflows and supported liquidity; even as new share issuance has accelerated.

Rapid inflows have, however, brought challenges. The Securities and Exchange Board of India raised concerns in 2024 about excessive flows into small-cap funds, prompting curbs to limit speculative activity. As inflows slowed and corporate issuance remained heavy, valuations came under pressure.

Elevated valuations have become the market’s main constraint. Indian equities have long traded at a premium to other EMs, reflecting optimism about growth and reform. Yet by late 2024, the market’s P/E ratio had reached 29x, its highest since the Covid-19 pandemic.

Such lofty levels left equities vulnerable to even small shifts in sentiment. Even a modest slowdown in economic and earnings growth combined with weaker inflows and abundant equity issuance, triggered a meaningful correction. 

Global dynamics have amplified this adjustment. For years, India’s steady expansion contrasted with China’s slowdown, drawing international capital. More recently, improving conditions elsewhere including Korea’s “value-up” reforms, Taiwan’s AI-driven cycle, and renewed Chinese stimulus have redirected flows. Foreign investors withdrew $17bn from India in 2025, matching the record set in 2022, as relative valuations encouraged rotation into other EMs.

External headwinds

Looking ahead, India’s outlook remains defined by strong fundamentals yet constrained by valuations, continuing to present a conundrum for value-oriented investors. Policy continuity, reform momentum and robust domestic demand underpin confidence in the country’s long-term growth trajectory. Recent interest rate cuts and tax adjustments are expected to provide cyclical support, while the economy’s largely domestic orientation offers some resilience against external headwinds.

Even so, valuations remain the most persistent challenge. Despite the market’s recent correction, Indian equities continue to trade at more than 25 times trailing earnings, a level elevated both in historical context and relative to other emerging markets. Equity issuance has also remained strong, creating potential oversupply at a time when foreign participation is subdued and domestic inflows have moderated.

These conditions suggest that patience and selectivity may be required. India’s structural strengths — with its expanding middle class, digital transformation and growing role in global supply chains — offer enduring long-term appeal. Yet, given current pricing, entry points appear limited. Near-term opportunities may therefore be best captured through targeted exposure to companies aligned with long-term structural themes rather than broad market participation.

While India’s story remains compelling, it continues to embody the paradox faced by many value investors: a market underpinned by exceptional fundamentals, but where elevated valuations constrain enthusiasm. The recent phase of underperformance suggests that a further derating may be needed before a new period of sustained outperformance can begin.

Andrew Miller, chief investment officer for emerging market equities, Mondrian Investment Partners