Indian equity markets have delivered disappointing returns in 2025, significantly underperforming emerging market peers despite widespread attribution of the weakness to U.S. tariff concerns. However, market data reveals that domestic factors, particularly elevated valuations and slowing earnings growth, present more substantial challenges than external trade pressures.

Performance Gap Widens with Emerging Markets

The performance divergence between Indian stocks and global emerging markets has reached notable proportions. In calendar year 2025, the MSCI India index posted modest returns of around 2.5% in U.S. dollar terms, while the broader MSCI Emerging Markets index surged nearly 28% over the same period, marking one of the widest performance gaps in decades.

This underperformance extends to local indices, where Taiwan's TAIEX gained around 35% over the past year and China's SSE Composite Index rose about 28%, while India's Sensex grew by just 7%. The divergence is particularly striking given that these markets have faced comparable tariff and trade-related pressures.

Valuation Premium Remains Elevated

A critical factor behind India's weaker performance lies in expensive valuations relative to emerging market peers. As of October 2025, Indian equities continue trading at significant premiums, with the MSCI India index valued at around 25.2 times trailing earnings compared to approximately 16.2 times for the MSCI Emerging Markets index.

This valuation gap reduces the margin of safety for investors and amplifies sensitivity to any negative developments. The premium has also influenced capital flows, with analysts noting inconsistent foreign portfolio investment into Indian equities as global funds seek better risk-reward ratios in cheaper markets.

Earnings Growth Momentum Slows

Corporate earnings performance has added pressure to the valuation challenge. Profit growth for major Indian companies slowed materially in FY25 and early FY26, reducing the earnings upgrades that traditionally support higher equity valuations. This deceleration occurred just as markets were already elevated from years of strong performance.

In contrast, other emerging markets have benefited from sector-specific tailwinds. Taiwan's technology sector has gained significantly from global semiconductor demand, while Mexico has enjoyed nearshoring investment flows that boosted investor sentiment. These earnings differentials help explain the outperformance of these markets despite challenging global conditions.

Limited Tariff Impact on Fundamentals

While U.S. tariffs introduced in mid-2025 disrupted trade flows and triggered short-term volatility in export-sensitive sectors like pharmaceuticals, textiles, and jewelry, the direct macroeconomic impact remains limited. India's exports to the United States account for a relatively small share of GDP compared to China's much larger trade exposure.

Moody's Ratings warned that higher U.S. tariffs could hamper India's manufacturing push and project a modest drag on GDP growth. However, the stronger performance of other emerging markets facing similar trade pressures suggests that tariff concerns alone cannot explain India's relative underperformance.

Market Outlook Challenges

The combination of high valuations and slowing earnings growth leaves Indian markets vulnerable to disappointments. Post-Covid easy liquidity conditions that fueled sustained rallies have normalized, with markets now demanding stronger corporate earnings to justify elevated multiples. The Reserve Bank of India's relatively higher interest rates compared to some global peers have also made equities less attractive relative to other asset classes.

Until corporate earnings demonstrate clear and sustained recovery or valuations adjust to more comfortable levels, Indian equities are likely to remain sensitive to both global developments and domestic challenges, with fundamentals rather than tariff headlines driving performance.

The Indian stock market has entered 2026 on a challenging note, with major indices experiencing significant corrections from their all-time highs. Market sentiment has deteriorated sharply in recent weeks, marking a clear shift from the optimistic start to the year.

Market Performance Overview

The current market correction has impacted different segments with varying intensity:

The broader market decline has been particularly painful for retail investors, as mid-caps and small-caps form the bulk of individual portfolios. This disproportionate impact on retail holdings has significantly dampened sentiment across Dalal Street.

Key Factors Behind the Market Decline

US-India Trade Deal Uncertainty

The pending trade agreement between India and the US has emerged as a major source of market uncertainty. Despite months of negotiations, several critical issues remain unresolved, with Russian oil imports becoming a key point of contention. President Trump has supported legislation imposing up to 500% tariffs on countries that import Russian oil, creating additional complexity for the trade discussions.

While media reports suggest the talks have reached an advanced stage with many points agreed upon, there remains no clear timeline for completion. Earlier reports indicated a potential March deadline, but neither side has provided assurance on this timeframe. Markets are particularly sensitive to this uncertainty, especially given the current 50% tariff on India that investors hope to see removed.

Slow Corporate Earnings Recovery

Corporate India's earnings performance has been disappointing over recent quarters, creating a cautious investment environment. The ongoing earnings season was expected to signal a recovery in sales and profit growth, but early results suggest a full earnings recovery may take several more quarters to materialize.

This extended timeline for earnings improvement has led to:

• Reduced expectations for rapid growth
• Hesitation among institutional investors
• A general wait-and-see approach from market participants

Geopolitical Tensions

Heightened geopolitical risks have added another layer of concern for investors. Key developments include:

• US actions in Venezuela
• Trump's threats regarding Greenland
• Escalating tensions with Iran
• Concerns about potential major conflicts

These geopolitical uncertainties have contributed to continued Foreign Institutional Investor (FII) selling, further pressuring market sentiment alongside the falling rupee.

Market Recovery Prospects

Despite current challenges, historical data provides some reassurance for long-term investors. In 2025, Domestic Institutional Investors (DIIs) contributed massive inflows of ₹7.44 trillion, significantly outweighing FII selling of ₹1.66 trillion. This domestic support has prevented more severe market corrections and suggests resilience in the Indian market structure.

Key Recovery Indicators to Watch

Investment Strategy Considerations

For investors navigating this correction, fundamental analysis remains crucial. Key questions to evaluate current holdings include:

• Are company fundamentals deteriorating?
• Have there been recent negative changes in business prospects?
• Did valuations become excessive without earnings support?
• Were there errors in original investment analysis?

Stocks with strong long-term fundamentals that have declined due to short-term sentiment may present opportunities for patient investors. The current environment emphasizes the importance of thorough due diligence and focus on companies with solid corporate governance and reasonable valuations.

While the timing of market recovery remains uncertain, the combination of strong domestic institutional support and India's long-term economic prospects suggests that patient investors with quality holdings may be rewarded over time.