Jonathan Garner, Morgan Stanley-1200 — Garner’s assessment suggests that India’s recent FII outflows are less a reflection of weakness in the domestic economy and more a consequence of an extraordinary global investment cycle centred around AI infrastructure.

India’s long-term growth story remains intact, but foreign institutional investors (FIIs) are increasingly directing capital towards North Asian markets that are benefiting directly from the global artificial intelligence (AI) investment boom, according to Jonathan Garner of Morgan Stanley.

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Speaking to ET Now, Garner said the primary driver of international capital flows today is earnings growth, and North Asia is currently delivering extraordinary numbers that are difficult for global investors to ignore.

“The most important driver of foreign flows is what is going on on the earnings side. And here the performance of India is perfectly reasonable. We are anticipating something like 15% earnings growth on a go-forward basis. The issue is that in North Asian markets—in Japan, Korea, and Taiwan—we are getting really spectacular earnings growth.”

Garner highlighted South Korea as a standout example, where earnings growth is expected to exceed 230% this year, driven largely by the AI capital expenditure cycle, alongside increased spending on energy, defence, and other infrastructure-related sectors.

According to him, this trend is not unique to India. Investors have also been reducing exposure to markets such as Indonesia, Southeast Asia, and even Australia as they rotate capital toward economies more directly linked to the AI-driven investment wave.
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India’s Fundamentals Remain Strong

While acknowledging the recent FII outflows, Garner emphasized that India’s structural economic story remains compelling. The country continues to deliver healthy earnings growth and remains one of the fastest-growing major economies in the world.

“India will post pretty good mid-teens earnings growth and has delivered consistently on earnings growth in an environment where GDP is growing faster than any other major economy.”

He noted that some short-term challenges remain, particularly around energy prices and their impact on growth. However, India’s broader earnings and GDP outlook remains robust.

Garner believes the turning point for global capital flows came around mid-2024, when enthusiasm surrounding AI infrastructure spending accelerated sharply. India’s relative outperformance against other emerging markets peaked around September 2024, coinciding with the rise of this powerful investment theme.

Where Does India Fit Into the AI Story?
One of the key questions for investors is whether India can emerge as a meaningful beneficiary of the AI revolution, particularly through its information technology services industry.

Garner observed that Indian IT stocks have recently shown signs of recovery, mirroring gains seen among software and services companies in the United States after a prolonged period of underperformance.

“The Indian IT services names actually have rallied in the last couple of days, which is interesting, and equivalent peer group software and services names in the US have also been rallying after a period of very extended underperformance.”

However, he pointed out that investors remain divided over the long-term impact of AI on IT services companies. The debate centres on whether these firms will be disrupted by AI or whether they will successfully leverage the technology to expand revenues and deepen client relationships.

“The jury is still out on that,” Garner remarked, noting that similar discussions are taking place across the United States, Europe, and Japan.

The Scale of the AI Spending Cycle
The sheer magnitude of AI-related investment is unprecedented.

Morgan Stanley estimates that global AI-related capital expenditure could reach approximately $900 billion this year and rise to nearly $1.25 trillion next year.

“These are very, very large numbers even relative to the scale of overall global economic activity.”

Garner compared the AI transformation to the restructuring that followed China’s entry into the World Trade Organization in 2001—a development that reshaped global labour markets and supply chains over more than a decade.

The AI transition, however, appears to be unfolding at a much faster pace.

He believes the current investment cycle will continue for several years, with spending expected to increase further in 2027. Any significant moderation in investment levels is unlikely before 2028.

Why Morgan Stanley Prefers Capital Expenditure Themes
Given these trends, Morgan Stanley has adopted a clear investment preference for companies tied to capital expenditure rather than consumer spending.

The earliest beneficiaries of the AI boom have been firms involved in graphics processing units (GPUs), memory chips, processors, data-centre infrastructure, and power systems. Broader economic benefits are expected to emerge later as companies adopt AI technologies across industries.

“That is why we have a thematic of preferring capex generally within our portfolios to the consumer.”

This positioning presents a challenge for markets such as India, where consumer discretionary businesses and financial services represent a significant share of the equity market.

Garner noted that lower oil prices and shifting economic conditions have added further pressure on consumer-focused sectors, making them less attractive relative to capital-spending beneficiaries.

Geopolitics and Energy Security Add New Dimensions
Beyond AI, Garner identified geopolitics as a critical factor shaping global investment decisions.

Morgan Stanley’s framework is built around four major themes: a multipolar world, AI and technological diffusion, demographic change, and energy security.

“It is likely to be a world of continued geopolitical rivalry and complexity, which introduces uncertainty for investors in the portfolio.”

The geopolitical environment has evolved from tariff-related concerns in recent years to broader worries about energy security and regional conflicts, particularly in the Middle East.

Despite these challenges, Garner believes India continues to benefit from favourable demographic trends. Its young and increasingly urban population remains a significant long-term advantage.

He also highlighted India’s growing role in energy infrastructure and capital goods, sectors that could help support both domestic demand and global energy requirements.

Consumption Theme Losing Momentum
For years, India attracted investors as a consumption-driven economy, with rising incomes and expanding consumer demand forming the backbone of many investment strategies.

However, Morgan Stanley’s view has shifted.

“We are not constructive on it.”

Garner said the combination of AI-led investment flows and broader geopolitical changes has reduced the attractiveness of traditional consumption-focused themes.

In his view, the market environment that supported consumption-oriented investing changed significantly after September 2024, particularly as AI-related opportunities began dominating investor attention.

Valuations Remain a Key Consideration
Valuation continues to be another challenge for foreign investors considering India.

Although Indian equity valuations have moderated from previous highs, they remain relatively expensive compared with several North Asian peers.

What makes the comparison more difficult, according to Garner, is that some North Asian markets are experiencing such strong earnings growth that their valuation multiples continue to decline despite substantial market gains.

“The forward PEs are actually declining. The earnings growth is so strong.”

He noted that while India’s valuation may appear attractive when measured through metrics such as price-to-book value, earnings-based comparisons currently favour markets like South Korea.

Ultimately, Garner believes the direction of global capital flows will depend on how long North Asia’s earnings advantage persists.

As of now, Morgan Stanley expects that trend to continue through 2027, with any meaningful slowdown likely occurring only in 2028 or later.

Outlook: A Temporary Shift, Not a Structural Rejection
Garner’s assessment suggests that India’s recent FII outflows are less a reflection of weakness in the domestic economy and more a consequence of an extraordinary global investment cycle centred around AI infrastructure.

India continues to offer strong structural growth, favourable demographics, and healthy corporate earnings. Yet for the moment, investors appear willing to chase the exceptional earnings momentum being generated by AI-driven sectors in North Asia.

Until that cycle begins to mature, capital is likely to remain concentrated in markets most directly linked to the global AI buildout

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