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Foreign portfolio investors may be returning to Indian equities, but the latest buying wave is not yet strong enough to be called a durable reallocation, according to Venugopal Manghat, chief investment officer–equity at HSBC Mutual Fund.
Global liquidity, interest rate expectations, currency stability and India’s relative valuation against other emerging markets will continue to shape FPI flows, Manghat said. While India’s valuation premium has moderated from its 2024 peaks, investors need to see stronger earnings growth and a reasonably stable rupee before treating the revival in foreign inflows as structural.
The following are the edited excerpts from the chat:
Q) Indian equities are increasingly being described as an earnings-driven rather than liquidity-driven market. Is the current earnings trajectory strong enough to support prevailing valuations?
A) I would say increasingly yes, although valuations still depend partly on liquidity. The earnings cycle has clearly improved, with Nifty profit growth accelerating and FY27–28 earnings expected to grow in the mid-teens. Early signs of improvement after the slowdown can be seen with Q1 FY27 earnings growth coming at a 10-quarter high and with marginal upgrades for the year.
At a broad market cap level, we believe the market has moved closer to an earnings-led phase with growth improving strongly. Also, the recovery is not confined to one industry, with autos, financials, metals, pharma and select consumer businesses contributing.
This gives us greater confidence that earnings, rather than liquidity alone, can increasingly support market valuations. That said, valuations are not inexpensive across the board. The key, therefore, is earnings delivery and stock selection rather than a broad-based expansion in multiples. This remains consistent with our bottom-up approach of favoring businesses where earnings visibility and return potential justify valuations.
Q) Q1 FY27 results have produced several positive surprises, but analysts remain cautious about upgrading full-year estimates. Are we seeing a genuine earnings recovery or merely a favourable quarter?
A) The recent results suggest that the earnings cycle is gradually turning more supportive, although it is still too early to call this a full-fledged recovery. Nifty 500 earnings growth is showing early signs of improvement after the slowdown, while the earnings upgrade / downgrade ratio has moved back above 1x, indicating that the earnings environment is stabilising.
The improvement is also supported by better domestic demand, resilient margins and a gradual revival in the investment cycle. However, greater breadth and consistency over the next few quarters will be important to establish that this is a sustained earnings recovery rather than a one-quarter improvement.
Q) How do you assess the risk-reward equation across large, mid- and small caps? Does the valuation gap warrant a decisive portfolio shift towards large caps, or can mid- and small-cap earnings catch up?
A) We don't believe the valuation gap alone warrants a decisive shift towards large caps. The more important question is whether earnings growth can justify the valuation differential. We think the earnings growth differential between large caps and the rest of the market may continue to remain as key sectors like IT and consumer staples may remain weak. On the other hand, many of the manufacturing industries have more mid and small cap companies and these are growing at a faster pace with the increasing opportunities from the domestic and global markets.
The latest numbers point to stronger earnings momentum in mid- and small-caps, with FY27 PAT growth estimated at around 16% for Nifty 100, 20% for mid-caps and 34% for small-caps, with healthy growth expected into FY28. This provides room for mid- and small-caps to catch up with earnings. However, given that small caps continue to trade at a premium, selectivity remains critical, with a focus on balance-sheet strength, cash-flow visibility and sustainable returns.
Our preference remains a diversified approach across market caps, driven by stock-level opportunities rather than a binary large-cap versus mid-/small-cap call.
Q) Foreign investors have started returning after an extended phase of selling. Is this the beginning of a durable reallocation towards India or a tactical trade driven by global liquidity and currency movements?
A) It is too early to conclude that this is a durable, structural reallocation. The recent return of foreign flows is certainly encouraging, but FPI behaviour may continue to be influenced by global liquidity, interest-rate expectations, currency stability and India's relative valuation versus other emerging markets. India's valuation premium has moderated meaningfully from the peaks of 2024, which improves the relative attractiveness of Indian equities. At the same time, domestic liquidity may remain a strong counterbalance to fluctuations in foreign flows.
For a sustained FPI recovery, we would want to see earnings growth improve, the rupee remaining reasonably stable and India's relative growth advantage persist. So, I would describe the current trend as constructive, but we need more evidence before calling it a durable structural shift.
Q) How do you view the outlook for banks and NBFCs amid improving credit demand but pressure on margins? Where are we positioned in the financial-sector earnings cycle?
A) Financials are moving into a more favourable phase of the earnings cycle. Credit growth is recovering and the latest data shows credit growth in high teens, which is a meaningful improvement from the moderation seen earlier. The near-term challenge is that deposit costs and competition could keep some pressure on margins.
But as the credit cycle strengthens and loan growth remains healthy, the operating environment for banks and NBFCs should improve. We therefore see opportunities particularly in well-capitalised financial institutions with strong liability franchises, sustainable credit growth and disciplined underwriting. The focus, however, should be on the quality of earnings rather than simply headline credit growth. Asset quality, capital efficiency and return on equity will remain critical differentiators.
Q) The market remains enthusiastic about capital expenditure, defence, manufacturing and infrastructure themes. Which indicators would suggest that these structural opportunities have become overcrowded or overvalued?
A) The investment cycle is one of the more important medium-term opportunities for India, supported by government infrastructure spending, manufacturing initiatives and improving private-sector participation. The latest indicators are encouraging. Capacity utilisation remains healthy and points towards improving conditions for private capex. At the same time, the broader earnings recovery can potentially reinforce the investment cycle.
However, the risk is that good structural themes can become poor investments when valuations run significantly ahead of earnings. We would therefore watch three things closely: first, earnings delivery versus expectations; second, order-book growth translating into cash flow; and third, return ratios and valuations.
If valuations rise much faster than earnings or if order-book growth does not translate into actual revenue and cash-flow generation, that would be a warning sign. So, we remain positive on the structural theme but will give adequate weightage to valuation.
Q) How is artificial intelligence (AI) changing the investment thesis for Indian IT companies? Is it a near-term risk to traditional revenues or a potential driver of the sector’s next growth cycle?
A) We see AI as both a disruption and an opportunity for Indian IT services. In the near term, there could be pressure on traditional, manpower-intensive services as automation improves productivity and clients reassess technology spending. This could create uncertainty around traditional revenue models and pricing.
However, over the medium to long term, AI could become a significant driver of technology spending. Enterprises will need to invest in cloud infrastructure, data platforms, cybersecurity, AI integration and digital transformation.
The key investment question is therefore not simply whether AI is positive or negative for IT companies. It is which companies can monetise AI-led demand while managing the disruption to their existing business models. We would favor companies with strong client relationships, differentiated capabilities, healthy cash flows and the ability to move up the value chain.
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