India–US Trade Deal, China Thaw, AI Push Are Key Market Catalysts In 2026: Morgan Stanley

For investors, the most profitable trades are often born in discomfort. As 2025 draws to a close, India finds itself in an unfamiliar and awkward position: its worst relative performance versus emerging markets since 1994. Foreign investors have cut exposure, relative valuations have compressed sharply, and India which was long treated as the default EM overweight has quietly slipped out of favour. That is precisely why the next few quarters matter, says Ridham Desai of Morgan Stanley.

Beneath the weak relative returns, the macro and policy backdrop is shifting decisively, he pointed in his note on Friday. India’s post-Covid, hawkish policy stance is unwinding, and history suggests that this phase of the cycle tends to reward investors who move early rather than wait for consensus comfort.

The most underappreciated change is the pivot from restraint to reflation. Over the past few months, the Reserve Bank of India and the government have begun working in tandem to revive growth momentum.

Rate cuts may be largely behind us, but policy support is far from over. The RBI is expected to continue bank deregulation, CRR reductions and surplus liquidity support, all of which improve credit transmission and lower the cost of capital.

At the same time, the government has front-loaded capex and announced nearly Rs 1.5 trillion in GST rate cuts, skewed towards mass consumption, a direct boost to demand rather than balance-sheet repair.

This combination matters. India’s previous growth phases were often fuelled by either fiscal or monetary support. This time, both levers are being pulled together, Desai pointed in the note.

Consensus remains cautious on earnings, but leading indicators suggest that may not last. Growth signals are improving across sectors, and we expect positive earnings estimate revisions in the coming months. If that materialises, it could be the trigger for a sharp sentiment shift, particularly given how light positioning already is.

Foreign portfolio investor exposure remains near cycle lows. Historically, that has limited downside and amplified upside once growth surprises emerge. Net FPI buying will likely require either clearer evidence of domestic growth recovery or a fading of bull markets elsewhere — but positioning suggests that the bar for positive surprise is low.

India’s policy pipeline adds another layer of optionality. The Union Budget in February 2026 could reaffirm fiscal discipline via progress towards primary balance, while also delivering market-friendly reforms.

Key possibilities include:

• Correcting inverted duty structures

• New production-linked incentive (PLI) schemes

• Capital market reforms, including fixing buyback taxation

• Broadening the FPI definition to allow more investor classes

• Making GIFT City fully tax-free

None of these are fully priced in, but collectively they would reinforce India’s long-term capital attractiveness.

Meanwhile, a potential India–US trade deal, including lower US tariffs on Indian goods, could provide a near-term sentiment boost. Add to that the thawing of relations with China and Beijing’s own “anti-involution” push, and external headwinds are beginning to ease rather than intensify.

February’s India AI Impact Summit 2026 could also help shape a credible AI investment narrative around Indian talent, services and infrastructure — an area global investors are actively hunting for beyond the US.

That said, investors should watch the supply side closely. Primary issuances were strong in 2025 and are likely to continue. Any bunching up of IPOs or block deals could cause short-term volatility in share prices, even if the broader trend remains intact.

If India is indeed heading for a positive growth surprise, leadership is likely to be familiar. According to Morgan Stanley, lenders, discretionary consumption, and select industrials stand out as the most direct beneficiaries of improving liquidity, deregulation and demand revival.