After a tough 2025, are Nifty Bulls ready for a strong 2026?

India was beset by multiple macro challenges in FY25 and 1HFY26. The government tightened its fiscal belt in FY25 by reducing the fiscal deficit by 46 basis points of GDP, mainly by keeping expenditure under control. At the same time, the RBI stepped in to tackle the exuberance in private lending through a series of regulatory measures, such as increasing risk weights on unsecured loans. This happened against the backdrop of tight monetary policy, with the repo rate remaining high at 6.5%.This resulted in a sharp slowdown in the economy, with GDP growth declining by 270 basis points to 6.5% in FY25. This had an impact on earnings, with Nifty’s EPS growth falling to 3.3% in FY25, after an extended double-digit period in the half-decade following the COVID-19 crisis. More worryingly, Nifty EPS forward consensus estimates for FY25 fell 4% between August 24 and February 25. The equity markets took a closer look and the Nifty corrected by 10% from Sep 30, 24 to Mar 31, 25, with small and mid-cap stocks experiencing even deeper corrections.

CY25 heralded a change in policy positions. The RBI started cutting rates on January 25, starting with a cut of 25 basis points and then by another 100 basis points. We close 2025 with a repo rate of 5.25%, the lowest since August 22. It also changed its stance on liquidity, putting the overall liquidity of the banking system in positive territory and attempting to keep it consistently above 1%. It reinforced this with a notable push for deregulation, lowering risk weights, lifting credit embargoes and diluting restrictive policies such as the Large Exposure Framework for large companies.The government followed this up with the GST reform on October 26. This is a game changer; Not only were tariffs reduced on a large portion of consumer goods, but procedures were also simplified, which should help SMEs do business more easily. There will be budgetary costs, but we believe they will be temporary, and the elasticity of demand should cover the costs within two to three years.

The effects of these measures are already visible in practice. Auto sales are up 20% for October 25 through November, and we expect total growth of ~25% for the holidays just passed. Demand should remain stable for much longer. The GST cut has significantly closed the affordability gap for entry-level cars, and the market has suddenly expanded. The rebound in demand extends beyond the auto sector to other discretionary growth categories.

This should drive a strong earnings recovery. Consensus forecasts for Nifty EPS predict 14% growth for FY27, after anemic single-digit growth for FY25 and FY26. More importantly, the 12-month cycle of downward revisions to forward earnings is starting to reverse, with an upward revision of 0.8% in November 25. The earnings forecast trajectory has been a major drag on the markets over the past fifteen months, and we are at an inflection point on this front.

Against this backdrop, we expect a strong year for Indian equities in 2026. The headline Nifty is likely to deliver 10-12% returns, in line with 2025 performance. We expect small and mid-caps to continue to outperform, driven by higher growth and continued strong balance sheets. Autos and consumer discretionary are at the top of our sectoral preferences. The sector is in the midst of a two- to three-year cyclical period, which should be broad-based across all segments: passenger cars, commercial vehicles and tractors. The positivity should spread to automotive suppliers, although we remain selective here and want to avoid players with high exposure to export markets.

The Internet sector is one of our favorites. India’s affordable data and deep smartphone penetration have opened the door for many disruptors to challenge incumbents with new business models. Some of these companies are loss-making, but that is a hallmark of platform models; they need to invest in the initial phase to build their customer base. High operating leverage makes these companies highly profitable as they mature. The rich valuations reflect the long-term growth potential.

Overall, we are overweight consumer discretionary, healthcare and basic materials, while underweight financials, basic goods and technology. In the financial and basic sectors, we see a challenge to long-term growth for larger players, who are ceding market share to smaller challengers. On the technology front, we believe the sector is in a cyclical slowdown with no prospect of recovery. The sector would become attractive if valuations were to decline further from here.

An important risk for the market is the external account. High US tariffs on India have affected the current account deficit, and this is being felt in continued pressure on the currency, with the rupee falling 5.3% since the first rate announcement on April 3. This poses an additional challenge for the RBI in its battle to keep bank liquidity above 1% of the NDTL. A solution to the trade problems between India and the US is the only sustainable solution to this problem; otherwise, Indian financial markets will experience periodic pressure attacks, with currencies, bonds and equities all affected. Moreover, we do not see a sustainable turnaround in FPI flows until the external account stabilizes. India’s dependence on FPIs has reduced over time, but a sustained rally in equities may still need the support of foreign investors.

(The author of the article is Seshadri Sen, Head of Research, Emkay Global Financial Services)

(Disclaimer: Recommendations, suggestions, views and opinions expressed by the experts are their own. These do not represent the views of The Economic Times.)