India’s domestic market and economy have been closely watching the ongoing trade negotiations with the US over the past two quarters. In particular, there was significant anticipation in the last two months that the US would at least remove the 25% penalty tariff. However, continued delays are expected to weigh on market sentiment, especially with the continuation of the sober foreign institutional investors (FIIs) view, INR depreciation and tangible volatility in the exports outlook. This delay is likely to prolong India’s underperformance, which we bear in 2025, at least in the early part of the new calendar year.
An inherent problem of the expected deal is the timeframe, which is expected to be finalised in two phases: first, the removal of the 25% penalty, and later, a comprehensive agreement. The latter is complicated by US demands for India to open its economy further, particularly in agriculture and dairy, areas where India is protective of small farmers. India already has comprehensive free trade agreements (FTAs) with partners such as the UK, Switzerland, Norway, UAE, Australia, New Zealand, and Oman, all based on similar principles. Meeting the US’s requirements is going to be a challenge and further delay the final deal. Sectors with significant exposure to US business, such as IT, Pharma, Textiles, and Jewellery, are particularly vulnerable to delay either by loss of business or sentiment.
There is a growing perception that the U.S. has pressure to finalise trade deals with major partners like China and India due to its heavy reliance on imports. A shortage of resources could push consumer prices higher, fuelling inflation and challenging the sustainability of protectionist policies. So far, the impact on US inflation has been less than expected, thanks to high inventories and cost-sharing between suppliers and buyers. However, as inventories decline and corporate profits fall, this arrangement may not last.
Notably, high inflation after the COVID-19 pandemic contributed to the Democratic Party’s loss in the 2024 election, and as the 2026 midterms approach, the Trump administration may ease its stance. Recent reports suggest the US has already begun cutting tariffs on key consumer imports, but if inflation remains subdued, Trump’s tariff policy could persist, given the strained US-India relations, and this will not be taken well by the market.
FII outflows
Other risks for India’s stock market include continued FII outflows led by India’s premium valuation and modest earnings outlook. And this trend could continue as profit-taking has begun in emerging markets following the strong performances by peers like Japan (26%), China (24%), South Korea (79%) and Taiwan (29%) in the last year, led by manufacturing and AI. Globally, markets are also experiencing a contraction in the AI boom.
There are concerns that AI-related stocks are overvalued and that the rally may be due for a correction, as revenue generation from AI has fallen short of expectations and the sector requires significant capital expenditure over the next five years. India is not an AI generator and may not be directly affected, but the technology sector could feel the effect through a slowdown in revenue generation and the broad domestic market from high valuation and weak FII sentiment.
Additionally, the risk of reversal in the yen carry trade is increasing, driven by rising Japanese bond yields, which could pressurise emerging markets and thus Indian equities, being a key component of the basket. This is likely to affect more EMs, who usually generate a large share of carry trade inflows. The overall impact on India may be muted, given its relatively poor performance and lack of FII exposure in 2025, thus lowering short-term positions. Still, since the valuations of India continue to be slightly above long-term trends, India’s underperformance could persist in the short term with muted FIIs inflows as external issues persist as a point of ponder for the domestic market.
(Vinod Nair is Head of Research, Geojit Investments Limited)
Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
