Daily Voice: Earnings growth set to rebound from Q2FY26 with these 3 sectors likely leading recovery, says Julius’ Unmesh Kulkarni

Aggressive fiscal consolidation, coupled with a stringent regulatory environment and a contraction in credit growth, had led to a slowdown in GDP growth as well as earnings in FY25. With the expected improvement in India’s macro environment, aided by a supportive fiscal and monetary policy environment, earnings growth is set to rebound from Q2FY26, although at a modest pace, with Nifty EPS growth expected at ~ 10% for FY26. The recovery is, however, likely to be uneven across industries, market cap and urban/rural.

Sectors that are exhibiting strong earnings growth include Chemicals, Cement, Capital Goods, Metals, and Construction, whereas Realty, Financial Intermediaries, Power, and FMCG have been weak / contracting. Large caps and mid caps have been so far reporting in-line earnings growth and are expected to improve from Q2. Small caps, which have witnessed earnings contraction, are also likely to witness a recovery in earnings.

Financials, Metal and Energy sectors are likely to lead the earnings recovery. Banks and IT are likely to see a delayed recovery, with NIM compression (resulting from RBI rate cuts) and loan growth slowdown likely to persist for Banks for another quarter or two, and tariffs continuing to cast uncertainties in the near term upon discretionary IT projects.

Rural demand remains strong, while urban demand is still struggling. However, the recent announcements related to rationalization of GST slabs, coupled with expectations of a good monsoon and the onset of the festive season, can act as a trigger for revival of domestic demand, and in turn benefit the Consumption-oriented sectors.

Given the apparent shift in the government's focus, do you now strongly believe this is the right time to bet on the consumption space?

The sentiment for the consumption space was weak over the past couple of years in the backdrop of a slowing economy (particularly, the stagnation in the rural economy). There is now increasing visibility of a recovery in rural demand and consumer staples, while urban discretionary demand is still lagging.

Rural demand is expected to improve further, with the cash/subsidy benefits aiding the recovery. There is visible growth pickup in smaller towns, with the growth of organized channels in e-commerce, quick commerce, staples, autos, etc.

The overall consumption space is likely to benefit, albeit at a modest pace, from low inflation, lower interest rates, surplus liquidity and the upcoming festival season, while the expected rationalisation of GST slabs is also likely to be a positive for consumption.

Are you bullish on the financial sector? Do you foresee healthy credit growth from banks starting in the second half of FY26?

With the RBI cutting interest rates by 100 bps since the start of CY 2025, net interest margins (NIMs) have contracted for most banks, both private and public, with private banks taking the larger brunt.

Margins are expected to further moderate in Q2 as the full effect of rate cuts is yet to be felt in the banking system. Housing Finance Companies (HFCs) are also experiencing transitory NIM compression due to the rate cuts, and high competition intensity putting pressure on yields, although the impact could differ across companies depending on the quantum of fixed-rate loans in their overall loan book.

On the other hand, credit growth has fallen from 20% levels (a couple of years) back to (less than) 10% currently, and is lagging behind deposit growth, as a fallout of the slowdown in the economy and demand, bond markets offering lower cost of funding and retail credit yet to pick up.

In terms of asset quality, private banks are seeing some deterioration, mainly due to seasonality and unsecured advances, whereas PSU banks have maintained healthy-to-stable asset quality.

The general and life insurance sectors have both experienced a slowdown on account of the slowing economy and fall in sale of ULIPs, respectively.

Overall, we remain positive on the financial sector. Most banks expect earnings growth to bottom out in H1FY26, with credit costs likely to improve as stress in unsecured lending subsides, although the NIM compression may continue for some more time. Vehicle financiers and affordable housing finance companies are likely to be key beneficiaries of the declining interest rate environment in FY26. Insurance sector can also get benefited in case there are some positive changes to the GST rates.

Bank credit growth is expected to pick up from the second half of FY26, with the RBI ensuring sufficient liquidity in the banking system and selectively lowering the risk-weightage requirements, besides frontloading the interest rate cuts for better and quicker transmission of the lower rates into the economy.

Do you believe the GST rationalisation will have a limited impact on the government’s balance sheet?

The Prime Minister recently announced a proposed rationalisation of GST tax slabs – current 12% and 28% to proposed 5% and 18% respectively.

The lowering of GST rates can have medium-to-long term positive impact as it aims to boost consumption and economic growth, while in the near term there may be some adverse impact on the government’s revenues and a manageable impact on India’s fiscal deficit.

The lower tax structure can act as a boost for consumption, particularly in the urban segment, which has been lagging for a while. Sectors such as FMCG, white goods, autos and cement can be potential beneficiaries. The proposed move is also intended to get the private capital expenditure back on track.

Besides, a simplified 2-tier structure can lead to improved tax compliance and therefore higher GST revenue collections in the long term.

However, there will be some impact on the fiscal deficit (due to the revenue loss), and the Government’s aim will be to offset any near-term fiscal costs with a positive impact on consumption and growth, thereby keeping the overall impact on the fiscal deficit at manageable levels. The benign crude oil prices could also provide some support to the Government finances. The actual implementation of the GST rationalization will depend on a consensus being reached between the Centre and States on the sharing of the revenue loss.

Despite the GST rationalisation, do you think tariff risks will persist—especially considering the unpredictability of Trump’s policy stance?

The Tariff situation has been evolving in a rather uncertain and dynamic fashion, with frequent changes in language and intent coming out of the White House. The current tariff rate for India - of 25% + 25% (penalty for importing oil from Russia) - is certainly undesirable, even though the direct impact on the Indian economy is limited, as India’s exports to the US are only about 2% of our GDP, and many sectors do not currently fall under the ambit of the tariffs.

The uncertainty, both in terms of timing and magnitude of the tariffs, is likely to persist until a trade deal is formally reached between India and the US, for which representatives from both nations are already in intense negotiations. The bigger uncertainty lies in the Russian oil import-related penalty, as this has wider ramifications for the Indian economy, which can ill-afford an escalation in oil prices.

What are your contrarian bets in the current market environment?

Two sectors that have underperformed and look interesting from a contrarian perspective are Consumption and IT.

Regarding the Consumption sector, as discussed earlier, the overall demand environment (especially urban) is expected to gradually improve, aided by an improving economic activity, benign inflation, good progress of monsoon, and the expected rationalization of GST slabs. An improvement in overall demand/volumes will support sentiment for the sector.

With respect to the IT sector, while there are certain near-term challenges on growth visibility amid impact of AI, as well as uncertainty regarding US economic growth and discretionary spends, we believe that valuations, especially for the larger IT companies, have started turning attractive post the recent correction of 20-25%. With a likely positive risk-reward at the current levels, the sector looks interesting from an investment perspective.

Lastly, one can also look at the generic Pharma companies which have recently seen some weakness amid uncertainties related to tariffs. We believe the US may not prefer to adopt a very stringent stance against the generic pharma companies, considering the risk of potential drug shortages/price increases, which would be supportive for the players.

Do you believe the market has already bottomed out and is now poised for a move toward new all-time highs?

After the secular rally upto September 2024, Nifty has been trading in a range for almost a year. There was a glimmer of hope with the recovery in the April – June quarter this year, but Nifty failed to break out and make a new high. Moreover, although Nifty has delivered a positive return so far in this calendar year, it has under-performed the global equity markets (both developed and emerging).

A number of factors have kept the sentiment for Indian equities in check – (1) Trump tariffs (2) FPI net outflows, about Rs 1.2 trillion YTD – almost the highest ever net outflow in a single calendar year (3) weak earnings growth and a tepid recovery and (4) high valuations (although moderating), especially in the mid-small cap space. The only silver lining for the markets has been the strong domestic retail flows, especially from Mutual Fund investors, which have been at record highs.

So what will change the perspective from here and take markets to a new high? While we certainly need an overall conducive global market environment, a well-balanced trade deal with the US can lift the spirits and bring back some of the flows from FPIs. A Russia-Ukraine deal will be a bonus, as it may lead to the softening of the US stance towards import of Russian oil by India.

The earnings recovery will be in motion from Q2FY26 and into the rest of the financial year, and this will set the stage for a longer term trajectory for Indian equities, with valuations starting to become more reasonable. Despite the near-term uncertainties, India remains one of the fastest growing economies in the world, and the ongoing structural reforms will go a long way towards wealth creation for investors through Indian equities.

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