Nilesh Shah on India’s Market Potential and Need for Tax Reform

Nilesh Shah, Managing Director of Kotak Asset Management Company, recently returned from a North America roadshow where he engaged with sovereign funds, pension managers, and family offices. His observations reveal a renewed global interest in Indian markets, supported by a shift in investor perception and valuation dynamics.

According to Shah, India continues to attract attention from major global investors, who now view the country not just as a high-growth story but as a structural bull market trading at reasonable valuations. "Two years ago, India was seen as an expensive growth story. Today, we can confidently present India as a structural bull market available at a cyclical valuation discount," he explained. This change comes as valuations have become more balanced, while India’s long-term growth potential remains robust. Additional factors like lower oil prices and a reallocation of capital away from AI-focused US markets have also increased India’s appeal.

Shah emphasized that foreign investors’ renewed interest is driven by both valuation appeal and a waning enthusiasm for the AI sector concentrated in the US. Emerging markets, particularly India, stand out because other large emerging economies face political, geopolitical, or economic uncertainties. "India is one of the few large and relatively-stable growth opportunities available," he said, while cautioning that the market is better characterized as a compounding growth story rather than one offering multi-bagger returns.

Regarding future returns, Shah recommended managing expectations. Investors seeking annual returns of 25-30 percent may find India expensive, but those aiming for consistent high-single-digit to low-double-digit compounding over the long term will find the market attractive. "India is fairly valued. Future wealth creation is likely to be driven more by earnings growth and compounding than by a significant rerating of valuations," he noted.

Domestic investors continue to play a vital role in supporting the market, with systematic investment plan (SIP) flows remaining strong and lump-sum investments rising alongside improved sentiment. Shah expects the Indian capital markets to deepen further with increased supply from initial public offerings (IPOs), qualified institutional placements (QIPs), and offer-for-sale transactions, helping to balance demand without causing excessive price inflation.

Despite the recent market recovery, Shah highlighted several risks investors should watch. Global factors such as energy prices, geopolitical tensions, and the US economic outlook can influence capital inflows to emerging markets. Domestically, consumption growth may be affected by credit conditions and borrowing costs. Additionally, government management of subsidies and fiscal policies, especially related to the Eighth Pay Commission, will influence economic stability.

Shah identified banking and financial services, premium consumption, and modern manufacturing as promising sectors. Banking benefits from strong asset quality and healthy credit growth, while the Eighth Pay Commission’s implementation is expected to bolster consumer spending in autos, durables, travel, and tourism. Modern manufacturing is gaining traction as India integrates into global supply chains, offering significant long-term growth potential.

On foreign investment positioning, Shah cautioned against expecting aggressive overweighting of India. Most global investors follow benchmark-driven approaches and are currently normalizing allocations. Those previously underweight are moving toward neutral, while those overweight may rebalance, indicating a correction rather than a surge in allocations.

Currency risks are factored into long-term investors’ models. Shah explained that pension funds and endowments focus on real returns and economic opportunity rather than short-term rupee fluctuations, which are expected to depreciate gradually over time.

Shah underscored the need for tax reform, particularly addressing the coexistence of the Securities Transaction Tax (STT) and Long-Term Capital Gains (LTCG) tax. He argued that STT was initially introduced as an alternative to capital gains tax, so having both simultaneously is inconsistent. He proposed eliminating one of these taxes and adjusting STT to better reflect market leverage. Shah also called for differentiated tax treatment for promoters and financial investors and advocated for consistent taxation of interest income across financial products to enhance transparency and investor confidence.

Looking ahead, Shah remains optimistic about India’s economic growth, projecting a steady expansion rate above 5 percent even amid global challenges, with potential to approach 7 percent under favorable conditions. However, he noted that achieving double-digit growth will require progress on structural reforms such as land acquisition, labor laws, agricultural policy, ease of doing business, and faster project execution. He pointed out that execution speed has historically set India apart from countries like China and will be crucial for future development.

On corporate earnings, Shah expects healthy growth across market capitalizations in fiscal year 2027, with large-caps growing 12-15 percent, mid-caps 20-25 percent, and small-caps 15-20 percent. Actual results will depend on commodity prices, subsidies, and overall economic conditions.

Shah’s key advice to investors is to keep expectations moderate and maintain patience. India may not offer deep value, but its long-term investment prospects remain strong. He encouraged investors to use market downturns to gradually increase exposure instead of chasing short-term gains, emphasizing that disciplined, long-term investing in India is likely to generate significant wealth through compounding.