During the last more than a year, India has been focusing on implementing growth-stimulating policies and programs. The massive fiscal stimulus provided through big income tax cuts in the 2025 Budget, the rationalization and cuts in GST, the implementation of the labor codes and the bold monetary stimulus provided by the RBI, have created a pro-growth environment, which is now producing the desired consequences. India’s GDP growth in FY26, has been estimated at 7.4 percent, making India the fastest growing large economy in the world for the fourth year in a row.
On the external front, the much-delayed US-India trade deal has been weighing on India’s labor-intensive exports and has been a major irritant for the stock markets.
This issue has been sorted out with the US agreeing to reduce tariffs on India to from 50 percent to18 percent. Earlier, things moved fast on the India-EU trade front with India and the EU signing the so-called ‘mother of all deals’ combining 193 crore people and $27 trillion GDP to form a formidable trade bloc.
Before the India-EU trade deal, India had signed trade agreements with the UK, Oman and New Zealand expanding the scope of trade.
What are the likely consequences of these policies and trade deals?
To what extent can growth be accelerated?
Will the stock market respond to the improving macros?
A major recent issue in the Indian economy has been the paradox of ‘strong macros, but weak micros.’ Growth has been impressive during the last five years post-Covid, with average annual GDP growth of 8.1 percent, factoring-in the estimated 7.4 percent GDP growth for FY26.
This is by far, the best growth performance among the large economies of the world. Yet this impressive growth performance didn’t translate into decent corporate earnings growth. After the initial burst in earnings growth post- Covid, which saw earnings growth of 24 percent CAGR during FY21 to FY24, earnings growth dipped sharply to a mere 5 percent in FY25 and continued to remain modest in FY26, too, even though there are signs of recovery.
The poor earnings growth during FY25 and FY26 can be largely explained by the plateauing of the bank profitability and slow growth in IT.
Record low inflation impacts nominal GDP
Even though the estimated at 7.4 percent real GDP growth has been impressive in FY26, the 50-year low GDP deflator of 0.6 percent restricted the nominal GDP growth to 8 percent.
It is important to understand that from the stock market perspective, nominal GDP growth is more important than real GDP growth. The revenue growth, and consequently the profit growth of companies, depend on nominal GDP growth.
Therefore, the 8 percent estimated nominal GDP growth of FY26 impacted earnings growth, which, in turn, kept valuations elevated and constrained a rally in the market. This construct of ‘strong macros, but weak micros’ is now changing. This has implications for the stock market.
Strong macros and improving micros
The bright macro construct continues. Aided by the fiscal and monetary stimulus of 2025, the growth-oriented and fiscally prudent Budget of 2026, the trade deals struck with the US, EU and others, the GDP growth in FY27 can rise to above 7 percent.
More importantly, with inflation expected to rise to about 4 percent in FY27, the nominal GDP growth can easily rise to about 10.5 percent, thereby favorably impacting corporate earnings growth. Corporate earnings have the potential to rise to about 16 percent in FY27. FIIs are likely to turn buyers in India in response to the improving fundamentals.
More importantly, the dollar depreciation of about 10 percent during the last one year has significantly eroded the real returns of foreign investors. When the market starts discounting these factors, a rally is likely; perhaps it is happening now.
But high valuations will limit the rally to modest levels. So, expect decent, not spectacular, returns in the rest of 2026. For the longer term the prospects are, indeed, bright!
(The author Dr. V K Vijayakumar, Chief Investment Strategist, Geojit Investments)
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