Financials: A Driver
Financials currently stand as a major force behind index earnings, showing a robust setup since the COVID era. This strength stems from positive earnings surprises,
a favorable regulatory environment, and limited market positioning. While rate cuts might exert pressure on Net Interest Margins (NIMs) in the near term, they're generally viewed as positive for medium-term credit growth. However, this sector faces potential risks, including competitive deposit pricing that could squeeze NIMs, a possible slowdown in retail credit normalization, and potential policy shocks. Despite these concerns, the base case scenario remains constructive through fiscal year 2027. Financials will continue to be a large driver of index earnings.
Consumption: K-Shaped Recovery
The recovery in consumption is uneven, presenting a K-shaped pattern. There's notable strength in premium and discretionary segments, but mass consumption is lagging. While mass consumption appears to be bottoming out, its revival is projected to be shallow due to sustained pressures. These pressures include persistent high inflation, weak farm incomes, decreased subsidies, and rising household leverage, with consumers prioritizing debt reduction over increased spending. Government policy support, estimated at approximately 1.9% of GDP by March 2026, boosts sentiment but primarily helps with balance sheet repair. Premium consumption is structurally stronger, fueled by wealth gains from real estate, equities, and gold, which supports demand in premium sectors such as autos, housing, travel, jewelry, durables, and services. Data reveals a widening divergence, with premium categories showing multi-year growth, while staples, apparel, footwear, 2-wheelers, and value retail struggle to match pre-COVID levels. The outlook anticipates a bifurcated trend through fiscal year 2027, with a mass recovery unlikely before the end of the fiscal year; the premium segment is seen as the key driver.
Capex: Slowing Growth
Capital expenditure (capex) growth is slowing, with projections of approximately 13% in fiscal year 2026 and about 10% in fiscal year 2027. This contrasts with the 19% growth seen between fiscal years 2021 and 2024, and carries a downside risk if the government attempts to meet its 4.4% fiscal deficit target. State capex is particularly vulnerable to reduced tax collection, challenges related to the Goods and Services Tax (GST), rising subsidies, and election cycles. The analysis suggests avoiding sectors dependent on government budgets, such as roads, rail, metro, and water projects. Instead, it favors sectors like defense, shipbuilding, power transmission and cables, and energy transition themes including renewables, grid infrastructure, data centers, semiconductors, and electronic manufacturing services (EMS), which offer greater visibility and are less exposed to these risks.
Trade Deal Impact
The completion of a trade deal between India and the United States would likely boost market sentiment and investment flows. However, broader macroeconomic trends are seen as more influential. The base case scenario for CY26 assumes the deal’s fruition alongside Federal Reserve rate cuts and a weaker US dollar, historically beneficial for Emerging Markets (EM) and Foreign Portfolio Investment (FPI) flows. Completing the deal would reduce uncertainty for IT and export sectors, potentially shifting FPIs to net buyers, particularly if the Nifty outperforms the S&P index. If the deal falters or tariffs increase, FPI risk appetite could diminish, creating sector-specific drags. However, this is not the base case scenario.
