Equity markets in India continued to move higher during the quarter as the economy saw a transition across many areas. There was a broad-based participation in the market rally as the economic growth outlook improved. Small- and mid-cap stocks with greater ties having to the domestic economic recovery have outperformed the large cap stocks for the year. Money raised through IPOs for the year has exceeded US $10 bn and has surpassed the IPO issuance in the past three years. The sub-advisor expects the IPO pipeline to remain robust over the next 12-24 months. Large numbers of financial, digital and technology companies are expected to go for public listing.
The pace of vaccine rollout accelerated, and India recently surpassed 1 billion vaccine doses. The number of new daily cases for COVID 19 remained subdued. The economic impact of the second wave was less than expected, though risk of a third wave remains.
The sub-advisor expects the trend growth for the economy to be 6-7% by FY 2023, driven by recovery in consumption and investment. The reopening recovery continued to gain momentum, supported by pro-growth fiscal policy and accommodative monetary policy. Exports from India were up. Higher uncertainty in China is advantageous for Indian companies, providing them an opportunity to become part of global supply chains.
Indian equity markets have seen an increase in foreign flows, rise in domestic mutual fund inflows and higher retail participation. Indian equities are seeing strong retail demand and there is potential for higher flows due to increased savings. Historically, the majority of household savings in India have been held in real estate and gold. Capital market inflows may likely remain strong, given the robust IPO pipeline. Given increasing regulatory risk in China, IPOs of new economy companies are likely to see strong investor demand and ensuing capital flows could keep equity valuations high. India saw strong foreign flows inflows in September, although there was some outflow in the last week of September.
Current headline valuations are elevated though medium-to-long term valuations based on normalized earnings seem reasonable. With no major earnings upgrades, India’s relative valuations in comparison to emerging markets have become richer after the continuing rally in equity markets. India has seen a late economic recovery process versus developed markets; therefore, it has the potential for catch-up now. Consequently, a recovery in earnings growth is also expected.
The sub-advisor is cautious about the market outlook in the short term, while being positive in the medium to long term. Inflation and Fed taper are the biggest tail risks. Rising energy prices are also a concern for markets: rising prices weigh on India’s current account deficit due to the country’s reliance on energy imports. Secular growth potential of new economy sectors lends support to the medium-long term positive view on equities. Indian equity indices could see larger representation of new economy sectors. Drawing a parallel with China’s experience, as large, digital IPOs become part of the indices, it is possible that the Indian equity index could evolve to a younger, faster-growing, digital but more expensive market. New economy sectors make up 60% of the MSCI China index (up from 20% a decade ago) and helped China deliver the best ten-year earnings per share (EPS) compounded annual growth (11% for China vs. 6% for the MSCI All-Cap Asia ex-Japan Index). The sub-advisor sees potential for India’s market capitalization outpacing its nominal GDP growth based on four factors:
- a larger economy
- larger share of formal economy
- larger share of Indian companies in the economy
- listings of new companies.
The sub-advisor has identified the following investment area as potential growth opportunities for the portfolio:
- Private/Corporate Banks: Structural story of increasing market share based on high capitalization, better asset quality and healthy liability franchise.
- Shift from unorganized to organized: Organized players continued to gain market share amid COVID crisis and had earlier benefitted from reforms like Demonetization, Goods & Services Tax etc.
- Low-ticket Consumer Discretionary: Discretionary consumption to increase due to low product penetration, improving affordability, increased electrification.
- Industrials & Infrastructure: High budget outlay for infrastructure, government announced production linked incentives (PLI) favourable for domestic manufacturing.
- Technology/Digital: Factors driving higher technology spend include modernization of core infrastructure; adoption of public and hybrid cloud model; and increased adoption of artificial intelligence.