While financials and industrials are clear beneficiaries of India's growth, the IT services sector is a contrarian opportunity. Currently facing uncertainty and disruption due to AI, the sector is overlooked and undervalued. As the impact of AI becomes clearer, IT services could emerge as a highly attractive area for investors who can tolerate the current confusion.
Recent policy changes, such as removing withholding tax on debt, are specifically designed to attract capital into India's debt markets to stabilize the currency. However, these measures are not expected to significantly impact foreign equity inflows, which are more dependent on an improved relative growth outlook or the start of a major IPO cycle.
The potential for AI to disrupt India's historically strong services exports introduces a new risk. To counter this, policymakers must urgently boost the manufacturing sector's competitiveness. This would not only diversify export revenues but also attract more stable, long-term Foreign Direct Investment (FDI) instead of relying on short-term capital.
Despite India's healthy absolute earnings growth, it pales in comparison to other markets like Korea, Taiwan, and Japan. This 'relative growth disadvantage' makes it challenging to attract short-term-oriented foreign investors who are currently focusing on markets with more dramatic growth stories, even though India's long-term prospects remain strong.