Andy Mukherjee: India's love for equity is being tested—can the US-Iran ceasefire restore confidence?

For the first time since the pandemic, individual investors were net sellers in the secondary market in the first 11 months of 2025-26. That sign of pessimism, which pre-dates the war, could become more pronounced because of the conflict.

Much of the 19% annualized three-year return on the Nifty Smallcap 100 Index came from a bumper performance in 2023 and early 2024. That will soon vanish. If the benchmark stalls at current levels, the new three-year return in March 2027 will be just 1.3%.

Unless valuations reset at more attractive levels, the psychological shock of low realized gains could pour cold water over expectations of future outperformance. At risk are systematic investment plans, through which the middle class has poured nearly ₹6 trillion into mutual funds since early 2024.

These plans are the “big bang” phenomenon for the Indian capital market, Bernstein noted. “We remain watchful of how retail investors behave if markets remain sideways for the next 12 months,” its analysts said.

Should people stop wiring small sums of money every month to mutual funds, the intermediaries that depend on them could be in big trouble. Before Wednesday’s ceasefire-inspired stock-market surge, HDFC Asset Management’s shares had fallen about 15% over six months. Brokerage Motilal Oswal had tumbled 25%.

Investment bankers are also on edge. From Mukesh Ambani’s digital empire to the National Stock Exchange, large initial public offerings are in the works. Beyond those marquee names, however, there may not be much investor appetite. PhonePe has delayed its IPO. Expect others to follow suit.

Ambani’s Jio Platforms listing is likely to consist entirely of an offer for sale by existing investors such as Meta and Alphabet. The company won’t receive fresh funding. This reflects a trend. Last year, more than 60% of the IPO fundraising in India ended up giving exits to firms’ original sponsors. The money didn’t create fresh assets. In fact, a lot of it may have left the country.

Overall, overseas investors have sold $22 billion of Indian equities over the past year. What will it take to bring them back? For one thing, New Delhi should rethink its capital-gains and securities transaction taxes—a buzzkill for global fund managers.

Besides, valuations may still need to become a lot more reasonable. On a price-earnings basis, the MSCI India Index is 70% more expensive than the MSCI Emerging Markets Index. While this premium is lower than at its 2024 peak, global investors clearly expect India Inc to cost even less.

That’s because of the elephant in the room: the rupee. Foreign investors usually factor in 5% annual depreciation to evaluate dollar-denominated returns. Over the past year, the rupee has weakened 8%. That’s a dampener, and not just for overseas investors. Affluent Indian households—the bulwark of India’s market—also have substantial foreign-currency liabilities. Effectively, their lifestyle is dollarized.

A lot is riding on the two-week ceasefire in the Gulf conflict. If the Strait of Hormuz reopens quickly and fully, India’s fiscal and current-account deficits may be elevated, but manageable. However, prolonged energy shortages could upend those calculations and the Reserve Bank of India, which left interest rates unchanged on Wednesday, may have to raise them to prevent an unruly collapse of the currency.

For a bank-led economy, large-scale migration of household savings into capital markets was always a risky strategy. The number of participants in the National Stock Exchange’s secondary market quintupled in five years through February 2025. From fund managers and distributors to exchanges and brokers, an entire industry benefited.

For a time, this ‘financialization’ of deposits sustained optimism by producing a wealth effect. Banks enabled their own hollowing out by lending ever-larger sums for share purchases. However, a lot of that money fed a speculative frenzy in low-quality, small-cap stocks.

Costs are mounting. Indian lenders are strapped for liquidity, which means borrowers aren’t getting the full benefit of RBI’s cumulative 125 basis points of rate cuts since early last year. Meanwhile, savers can no longer find attractive yields in equities. The rank of new retail entrants thinned by 24.5% in February.

Throw in the shock of seeing three-year returns dwindle to nothing, and both investors and intermediaries may have a tough slog ahead. ©Bloomberg

The author is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia.