India's recent decline in market valuations is likely to be a temporary, cyclical phase rather than a long-term structural shift, and an acceleration in economic growth could help reverse the trend while providing fresh momentum to domestic equities, according to a report by Morgan Stanley.
The report noted that the combination of relatively weak recent market performance and reduced foreign investor ownership has created conditions that could prove favourable for Indian equities in the coming months. "India's relative de-rating is cyclical and with growth acceleration in the pipeline, it has potential to reverse," the report stated.
Morgan Stanley argued that concerns suggesting India's market de-rating reflects deeper structural weaknesses are overstated. One commonly cited reason for a structural decline is the expectation that India's long-term economic growth could slow because of falling fertility rates. Another concern is that the rapid adoption of artificial intelligence (AI) could undermine India's services exports and weaken its position in global trade.
However, the report said both arguments overstate the risks. It pointed out that although fertility rates have been declining, the trend has been gradual rather than abrupt. As a result, demographic changes are expected to continue supporting India's economic growth over the next two decades, even if they gradually reduce the country's long-term demographic advantage.
On AI, Morgan Stanley acknowledged that the technology could create near-term challenges for India's services exports as businesses adapt to automation and changing demand patterns. At the same time, it said AI presents a major medium-term opportunity by improving labour productivity, particularly given India's relatively low productivity base.
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The report further highlighted several structural drivers that continue to underpin India's long-term growth outlook. These include the emergence of a more multi-polar global economy, which could expand India's share in global goods trade, a steadily growing consumer market and a sustained increase in investment activity.
Based on these factors, Morgan Stanley concluded that the recent decline in India's market valuation is largely cyclical and primarily reflects the country's relative economic growth gap compared with other global markets rather than any deterioration in its long-term fundamentals.
The report added that while India's economic growth appears to have bottomed out and is now showing signs of improvement, it continues to lag behind some economies that are benefiting more directly from the ongoing global artificial intelligence-driven capital expenditure cycle.
Looking ahead, Morgan Stanley said the direction of Indian equities will depend largely on how investors assess the relative growth outlook between India and the rest of the world. According to the report, market sentiment could improve if enthusiasm surrounding global AI-related capital expenditure begins to moderate or if India's domestic growth gathers further momentum.
Morgan Stanley also expects the upcoming quarterly earnings season to serve as an important catalyst for the market. It believes Indian companies have the potential to deliver positive earnings surprises, supported by encouraging high-frequency economic indicators that point to improving business activity and demand conditions.
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