Indian equity markets delivered muted returns in August amid rising crude oil prices and heightened geopolitical tensions, with broader markets outperforming large caps. The BSE Sensex and Nifty 50 declined 1.5% and 1.2%. The broader market outperformed, with mid-cap and small-cap indices gaining 2.1% and 3.1% respectively. Sector performance was mixed, as FMCG and power lagged while capital goods and metals posted gains.

Foreign institutional investors were net buyers during the month, infusing US$3 bn in equities and providing an additional boost to market sentiment despite ongoing concerns around crude oil prices and geopolitical developments. Domestic institutional investors poured in US$ 6.1 bn in August.

Key domestic developments included changes to the derivative market closing-price mechanism, the RBI maintaining policy rates, government initiatives worth US 130 bn to support infrastructure and address inflationary pressures following sharp rise in sugar prices and measures by the US government to encourage long-duration government bond issuance.

Indian government bonds remained volatile in August, with the benchmark 10-year G-sec yield hardening from around 6.81% at the beginning of the month to about 6.95% by month-end. Bond markets were influenced by a combination of rising crude oil prices amid geopolitical tensions in West Asia, a pickup in domestic inflation expectations, and uncertainty around the global rate trajectory. While the RBI's decision to keep the repo rate unchanged and maintain a comfortable liquidity environment initially supported bonds, concerns over higher oil prices, inflation risks and the early closure of the FCNR(B) swap window weighed on sentiment, leading to a rise in yields during the latter half of the month.

Key Market Events

Earnings seasons strong : The earnings season concluded on a strong note, with healthy year-on-year earnings growth and nearly 60% of companies reporting profit surprises, led largely by commodities and financials. More importantly, demand trends remained robust across financials, consumer, pharma, industrials and textiles. Industrials and capital goods continue to benefit from a broad-based capex cycle spanning power, transmission & distribution, data centres, infrastructure and manufacturing.

Rupee sees a modest gain : The Rupee strengthened modestly against the US dollar in August, ending the month around 0.2% higher, supported by sustained RBI intervention and healthy foreign portfolio inflows. However, it underperformed several emerging market peers as rising crude oil prices and renewed geopolitical tensions weighed on sentiment. The US dollar strengthened towards the end of the month following hawkish commentary from the Federal Reserve, which led markets to reassess the path of US interest rates. Despite these external headwinds, robust capital inflows and strong foreign exchange inflows under the RBI's concessional deposit window helped keep the rupee resilient.

FCNR deposits garner strong inflows : The exceptional response to the RBI's FCNR(B) mobilisation scheme surprised markets, with deposits reaching US$127.2 bn and total inflows under FCNR(B), ECB and OFCB measures touching US$136.3 bn. The scale of these inflows not only strengthened India's external position and supported currency stability but also created a substantial liquidity surplus within the banking system. Given the strong participation, the RBI opted to close the scheme early on 31 August, ahead of the planned 30 September deadline, shifting the market's focus from inflow mobilisation to the central bank's liquidity management strategy.

GDP growth resilient despite geopolitical tensions : Real GDP growth surprised positively at 7.8% in 1QFY27, driven primarily by strong investments and exports. Gross fixed capital formation (investment) grew 11.9% while exports rose 12%, providing the key impetus to growth. On the supply side, services remained the largest contributor, led by financial, real estate and professional services growth of 12.1%, while manufacturing accelerated to 9.2% and construction remained healthy at 7.7%. Private consumption growth of 7.1% was supportive but not the key driver, while agriculture growth moderated to 3.6% due to weather-related disruptions. Nominal GDP growth came in at 10.3%, stronger than expected but still constrained by a low GDP deflator of 2.3%, reflecting subdued inflationary pressures.

Inflation largely stable in July : Headline inflation rose to 4.45% in July 2026, up from 4.38% in June, staying above the RBI's 4% medium-term target but remaining comfortably within the central bank's 2-6% tolerance band. The increase was largely driven by food inflation, which accelerated to 5.52%, reflecting higher vegetable prices. Meanwhile, underlying price pressures remained muted with core inflation at 4.16%. However, risks to the inflation outlook have increased from higher crude oil prices, weatherrelated disruptions to agricultural supply, and the possibility of food inflation remaining elevated for longer.

Equity Market View:

West Asia continues to be the key global macro risk, keeping oil prices, energy costs and supply chain uncertainties elevated. At the same time, a more hawkish US rate environment has pushed bond yields and the US dollar higher, tightening global financial conditions. Meanwhile, the AI investment cycle remains a powerful structural theme, although investors are becoming more selective, favouring clear beneficiaries over companies pursuing aggressive capex without visible monetisation. As a result, oil prices, interest rates, global liquidity and the sustainability of AI-driven investments remain the key variables shaping market direction.

Nonetheless, domestic fundamentals are becoming increasingly supportive after a softer FY26. Economic activity indicators remain encouraging, with strong momentum in credit growth, healthy trends in housing and consumption, and sustained strength in power demand and investment activity. Inflation normalisation is expected to lift nominal GDP growth in FY27, creating a more favourable environment for businesses and household spending. The combination of improving liquidity, stronger economic activity and a more supportive nominal growth environment provides an important foundation for the next phase of the economic cycle.

India's premium vs world remains compressed, while premium vs EMs remains elevated after the correction in Taiwan and Korea. Looking ahead, we expect improving earnings momentum, relatively low valuationpremiums and better FII/DII flows to support market returns despite rising equity supply and persistent global risks. At a domestic level, valuation dispersion across market caps remains elevated. While pockets of the midand small-cap universe continue to trade at rich valuations despite recent corrections, large caps offer a relatively more balanced risk-reward profile, supported by reasonable valuations, stronger earnings visibility and healthy balance sheets. That said, we do not view this as a large-cap-only market. Opportunities exist across market segments, but investors should adopt a selective and valuation-conscious approach, focusing on businesses with sustainable earnings growth, durable competitive advantages and reasonable valuations while maintaining diversification across large, mid and small caps.

Overall, we remain focused on long-term structural growth opportunities backed by domestic economic drivers rather than short-term macro trends. Our preferred themes continue to include banks, consumer discretionary, manufacturing linked businesses, domestic capex, power and transmission & distribution, industrials, defense and electronic manufacturing services (EMS). We favor companies that are well-positioned to benefit from India's ongoing investment cycle, manufacturing expansion and formalization of the economy, while maintaining resilience against global macroeconomic and commodity-related volatility. We have been cautious on sectors such as consumer staples where margins remain vulnerable to input cost pressures or where the earnings outlook is still unclear.

Fixed Income Market view

The strong response to the RBI's FCNR(B) mobilisation measures, led to the scheme being closed ahead of schedule after attracting substantial inflows. The resulting foreign currency inflows have significantly strengthened India's external buffers and created a sizeable liquidity surplus in the banking system. While this abundant liquidity remains supportive for money market rates, corporate bonds and carry strategies, the market's focus has now shifted from the pace of FCNR collections to the RBI's liquidity management response. Any measures to absorb excess liquidity through VRRR operations, FX swaps, OMOs or reserve requirements could influence the near-term trajectory of bond yields. On balance, FCNRrelated inflows provide an important cushion against external shocks and help mitigate currency and funding risks, but elevated global yields and oilrelated inflation concerns are likely to cap the scope for a meaningful rally in duration. Going forward, we remain focused on three key variables: the trajectory of US inflation and Fed policy expectations, the persistence of higher crude oil prices, and the RBI's approach to managing the FCNRdriven liquidity surplus. We continue to prefer the 3-5 year segment of the curve, particularly high-quality corporate bonds, while expecting the 10- year G-Sec yield to remain broadly range-bound in the near term.

The US economy continues to exhibit resilience, supported by a strong labour market, healthy consumer spending and sustained investment activity. At the same time, inflation remains above the Federal Reserve's comfort zone and is expected to decline only gradually. This combination of resilient growth and persistent price pressures has prompted a reassessment of the Fed's policy trajectory, with markets increasingly pricing in the possibility of further rate hikes over the course of the year.

The fixed income opportunity remains attractive, but selectivity is key. We prefer the 3-5 year segment of the curve, particularly high-quality corporate bonds and select SDLs, where favourable carry, ample liquidity and limited CD issuance create an attractive risk-reward balance.

Source: Bloomberg, Axis MF Research.