Outperformance of Indian equities set to continue

Risks are still abundant and a few recent instances include the Bank of England action in UK Gilts, bid on credit default swaps (CDS) of systematically important banks. The widening of 1-month Forward Rate Agreement – Overnight Index Swap (FRA-OIS) Spread is indicative of dislocations. Hence, a debate on hard versus soft landing is hysterical and most are betting on the former, especially for key economies like the UK & EU.

Indian markets continued to display resilience (12% decline in dollar terms), even when key Emerging Market Index (MSCI-EM Index) has fallen 30% year-to-date. Even though the risk of rupee depreciation-driven imported inflation, coupled with material current account deficit deterioration or domestic food inflation (food has 55% weight in Indian CPI), remain, most of these are already moderately priced by rates and equity markets.

On a top-down assessment, among the major economies, India is the only one expected to grow at 6% in CY23 and has one of the lowest negative real rates (policy rate – inflation rate) of minus 120 bps versus more than minus 500 bps in key developed markets. This is coupled with the mid-cycle spoils of rising tax collection, rising credit growth and improving capacity utilization .

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It is a promising scenario for mid-cycle plays like banking, cyclicals and consumption. Banking, which is one-third of stock market cap weight, is coming out from a clean-up. Asset quality issues have ebbed, and the sector is seeing credit growth resurging to the best in last five years because of retail and MSME. Price performance-wise, banking has still not fared as well as key sectors like IT and auto. With credit growth picking up to 16% and loan growth to be around 13-14% in FY23-24, the banking universe is expected to deliver 41% y-o-y growth in net profit.

Auto and consumer discretionary that typically does well in mid cycle, especially with India per capita income rising beyond $2,000, is in the reckoning as well. Both these sectors were under margin duress. While auto sector is likely to see margin improvement of 300bps, coupled with strong volume growth (aided by low base effects of Q2FY22), weakening global macros can limit the magnitude of price performance. On the consumer discretionary side, companies are expected to take price cuts and thereby boost volumes in 2H of FY23.

The most compelling story comes from resilient fund flows. On the domestic money flow, while the role of SIPs is well documented (average ₹12,000 crore per month in the last four months), the role of retirement fund allocation (the average equity ETF flow was ₹15,000 crore) is still not well understood, as these are stable pools of money that will continue to come in. Additionally, FII money flow also has witnessed a tectonic shift. In the last 20 months, the weight of India in MSCI EM Index has increased by over 700 bps to 15%, while that of China has reduced by over 1,200 bps. With more than 90% of the FII money flow for India coming from EM dedicated funds, peaking out of interest rates and a stronger dollar is likely to trigger strong inflows into India. Additionally, India boasts of a profitable and clean banking system in the EM space—the largest sector in MSCI-EM Index.

To sum up, even if the western world stock indices remain dislocated, the India story will stay the course and recover faster.

Azeem Ahmad is head & principal officer, LICMF PMS. The views expressed here are personal.