Oil Shock, AI Capex Slowdown Pose Risks to India's Recovery from Q2FY27

India's ongoing cyclical economic recovery is facing a fresh set of headwinds, with a new analysis from Nuvama Institutional Equities pointing to potential risks from an oil supply shock, fading domestic stimulus, and a slowdown in artificial intelligence (AI) capital expenditure.

The report suggests that the impact of an oil supply shock on corporate margins is likely to become visible from the second quarter of the next fiscal year (Q2FY27). This projection follows a pattern observed during the 2022 conflict, where smaller companies and cyclical sectors experienced more significant profit erosion. The report notes that inventory gains, which helped cushion margins in the first quarter, are expected to reverse from Q2FY27.

Simultaneously, the global AI investment boom, which has been a key driver for markets, appears to be losing steam. If this trend persists, the positive effects of AI spending on exports and metal prices could diminish from the second half of FY27. The analysis flags concerns that major technology firms are facing rising chip costs, increased competition from China, and weaker cash flows, potentially forcing them to rely more on debt. A continued slowdown in hardware technology stocks after a sharp rally is also cited as a potential early warning sign, reminiscent of the period before the dot-com bubble burst in 2000.

Adding to the pressure, a hawkish Federal Reserve and rising global bond yields could weigh on risk assets. The report attributes the yield increase to tighter central bank policies and changes in global dollar recycling, which could dampen valuations and demand, especially given weak consumption and real estate landscapes worldwide.

The report also highlights that the Indian equity market's flat index performance over the past two years masks significant internal divergence. India has underperformed emerging markets, and large-cap stocks have lagged behind small- and mid-caps. This divergence is attributed to the AI capex boom and domestic policy support, such as GST cuts and regulatory easing by the RBI. However, the report warns that for the earnings gap to be sustained, the cyclical recovery must broaden, as the benefits from a low base have already been realized.