Indian Equities: A Bright Spot in Global Portfolios

• India is in a global bright spot, supported by resilient economic growth momentum, robust corporate earnings, sound monetary policy, and a broad-based recovery in sectors from financials to autos to fast-moving consumer goods, as reflected in strong local credit growth.

• Previous constraints, such as capital and energy, are much less of a concern today, given the banking sector’s expansion and resilience along with India’s significant investments in decarbonizing its economy and shifting energy dependency toward renewables.

• India’s macro stability and encouraging market dynamics helped the valuation of its stock market to hit an all-time high of US$3.8 trillion in September 2023 – and there is scope for further growth, given India’s underrepresentation in the MSCI EM Index.

India continues to impress on an array of economic and market fronts. The country is a bright spot amid broader uncertainty and investment “fog.” Its solid growth momentum is expected to pick up even further over the next 12 months, with strong expansion in output and new orders set to augment already surging foreign inflows. India’s robust corporate earnings and broad-based recovery in sectors from financials to autos to fast-moving consumer goods, reflected in expanding local credit growth and supported by sound monetary policy, are contributing toward an economy that offers resilience and promise. This positive outlook was echoed in the October 2023 World Economic Outlook briefing from the International Monetary Fund (IMF), which raised India’s GDP projection by 0.2 percentage points, to 6.3%, for both this year and next, while slashing the global growth forecast to 3%. 1 Emerging market GDP growth was forecast at 4% for both 2023 and 2024.

Well-anchored growth

India’s encouraging market dynamics came together in early-September 2023, when the valuation of the country’s stock market hit an all-time high of US$3.8 trillion. Coupled with foreign inflows of US$14.6 billion year-to-date as of the same month,2 these trends make a compelling case for investors to consider boosting allocations to Indian equities within a global portfolio. 

The timing of this achievement was also fortuitous, coming as India hosted the G20 summit, becoming the first country in the southern hemisphere to do so.

These developments highlighted the wider success story of Indian progress, where already a year ago the country had overtaken the UK as the fifth-largest economy globally.3 Furthermore, India’s diplomatic neutrality has strengthened its geopolitical ties among many countries, helping to attract investment and reinforcing its growing influence on the world’s economic and political stage.

It has been clear for some time that India can count on attributes such as a broad domestic market, a youthful and technologically savvy labor force, and an expanding middle class. However, until recently, its domestic economic growth has been constrained by two factors: capital and energy. Today, these are less of an issue.

Indian banks, for example, are experiencing enviable growth – amassing US$30 billion in profits on an equity base of US$200 billion, according to listed bank data from Bloomberg, as of March 2023. At the same time, credit to the private sector is growing at roughly 15% per year, which should support capacity creation on the one hand, and retail demand on the other.

Core industries including steel, cement, electricity, gasoline, and diesel are also growing. And with strong foreign portfolio flows, companies can raise equity at high valuations, in turn creating a more reliable capital-raising environment.

India has also been proactive in tackling energy constraints. India was the third-largest energy consumer in the world after China and the United States in 2021, according to the BP Statistical Review of World Energy 2022. We believe it will catch up, as India’s large industrial sector and growing consumer market will require a lot to fuel them. To meet these demands, the Indian government is looking to tackle uncertainties around energy prices by simultaneously investing heavily in renewable energy. The country’s aggressive energy transformation agenda includes solar energy and a push for green hydrogen.

More broadly, investors can expect to capitalize on India’s wider reform agenda. This includes initiatives to leverage digital technology to improve the ease of living and doing business. In turn, this should help boost corporate returns on equity, plus enable the country’s micro, small, and medium enterprises, which are responsible for nearly one-third of India’s GDP, to access credit and grow.

An resilient macro story

The financial sector is another important pillar for India’s economic growth and stability. The asset quality of domestic banks, for example, has improved, with a decline in non-performing loans contributing to robust balance sheets. The personal loan segment has also driven credit expansion in recent years, recording 19.7% year-on-year (YoY) growth in March 2023, compared with 16.5% YoY a year earlier, with the share of personal loans in total credit increasing to 28.6% YoY in March – from 21.5% YoY five years ago and 16% YoY a decade ago.4

Other common reasons for instability in an economy, such as fiscal deficits and excessive imports, are not immediate concerns for India. In fact, India’s GDP reached a high of US$3.4 trillion in the previous 12 months as of June 2023, on the back of consumption and investments growing faster than during the pre-Covid years. Moreover, government expenditure has slowed, and the net export balance has improved. More specifically, exports of services are performing well, with growth in technology service exports continuing unabated and business services exports having picked up since the pandemic. In line with this, foreign exchange earnings from remittances by Indian citizens working overseas are now approaching US$60 billion a quarter, equivalent to nearly 7% of annual GDP.4

Keeping a watch on runaway growth

Despite the optimism, India must still be wary of some short- and longer-term risks. First, and most notably over the coming months, the country faces high valuations bias in the small and mid-cap segment of the equity market, especially given that the bulk of the MSCI India’s performance has been driven by the mid-cap index. This segment is up given a low base and is also driven by the tendency for small and mid-cap stocks to perform well in a stable or rising interest rate environment, which enhances borrowing capacity for operational purposes. Yet our analysis suggests that this rally is likely unsustainable over time. As an illiquid segment of the market, a lot of fund flows came from foreign institutional investors who rushed to grab the opportunity, triggering a herd mentality as other investors followed, ignoring the fundamentals. Some of the recent company earnings results of these mid-caps show that they perhaps do not justify such high valuations. Second, on the energy front, geopolitical developments could have an impact on India if various fuel prices rise significantly. However, India is investing a huge amount in decarbonizing its economy, and we believe its dependence on fossil fuels will decline over time. All told, while short-term factors can affect market performance, the long-term trend for India is quite positive, given the country’s prevailing macroeconomic stability, abundant capital, and realignment of global supply chains to improve their reliability, along with a rapidly improving digital infrastructure.

A bigger portfolio presence

Ultimately, a resurgence for Indian stocks could make them attractive enough among global investors to play a bigger role in equity portfolios. The MSCI EM Index underrepresents India when compared with its share of GDP among EM countries. By allocating more to the country, therefore, investors could capture more of its potential. At the same time, beyond high valuations in some segments of the market, such as consumer and cyclical companies, as well as small and mid-cap names, we see pockets where India still offers excellent value – such as in financials, health care, and technology – especially among large caps. Investors should be encouraged by the wave of domestic money, too. Although the surge in retail activity has been concentrated in the small and mid-cap stocks, these funds have enabled many of these businesses to raise low-cost equity capital. This has helped fuel the overall acceleration in India’s economic growth, making it more diverse and sustainable.