India’s Equity Revolution

Is the Indian stock market overheated? The price-earnings (P/E) ratio of the BSE Sensex in April 2024 was 25.23. In February 2021 it was 36.21. So stocks have corrected, evening out post-pandemic anomalies.

A country’s stock market valuation depends on three key factors. First, the growth rate of the economy. Second, the profit trajectory of listed companies. And third, political stability. 

India’s long-term GDP annual growth rate at eight per cent is likely to be at least twice the average growth rate of global GDP. Can India sustain this growth rate over the next several years?

Services account for nearly 60 per cent of India’s overall GDP. If the services sector grows at 10 per cent a year, that would straightaway contribute six per cent to overall economic growth. On that strong base, if industry (with around 25 per cent weightage in GDP) and agriculture (15 per cent) grow even at a modest average of five per cent annually, they would contribute another two per cent to GDP growth. This would enable the economy to expand at a sustainable eight per cent per year well into the next decade. 

What about corporate profit growth? The Indian corporate sector’s net profit has risen at over 10 per cent a year after the Covid pandemic, taking both the Gaza and Russia-Ukraine conflicts in its stride. Despite trade disruptions and elevated crude oil prices, the pharmaceutical, banking, capital goods and infrastructure sectors are posting healthy returns.

The slowdown in FMCG spends is gradually easing while the infotech services industry is set to enjoy a better FY25 than FY24. Three rate cuts by the US Federal Reserve beginning June 2024 are likely this calendar year. That will boost US companies’ appetite for larger tech budgets. 

The third factor influencing stock prices is political stability. The Sensex and Nifty have priced-in an NDA victory in the 2024 Lok Sabha election. The scale of the win will determine how the market reacts.

No one in the Narendra Modi government is likely to forget the BJP’s “India Shining” slogan before the party plunged to defeat in the 2004 Lok Sabha poll. So confidant was the party’s think tank led by the late Pramod Mahajan that it convinced Prime Minister Atal Bihari Vajpayee to advance the election from September 2004 to March 2004. Sure of victory, the BJP instead saw its seat tally fall from 182 to 138. The Congress with just seven more seats at 145, stitched together the UPA-I government with the help of the Left’s 59 MPs and other allies. 

Modi isn’t Vajpayee. If the NDA does win a convincing majority in June 2024, the stock market will continue its four-year-old bull run. It knows that Modi’s first term (2014-19) was spent fixing the broken economy he inherited from UPA-2. His second term (2019-24) was disrupted by a once-in-a-century pandemic and two wars.

A likely third term will focus on turbocharging growth. The priority will be big-ticket economic reforms. The establishment of Tesla’s electric vehicle (EV) manufacturing facility in India, Apple’s ramped-up production of i-Phones, the new plants for semiconductor chips being set up by Tata and US-based Micron, and India’s inclusion from June 2024 in JP Morgan’s emerging markets (EM) bond index are all positive factors. 

On a micro basis, the surge in retail demat accounts suggests strong demand for equity and bonds. On a macro level, the three factors of GDP growth, corporate sector buoyancy and political stability point to the demand being sustainable.

Manish Sabharwal of Teamlease Services and Dhiraj Agarwal of Ambit Investment Managers pointed out in a Mint op-ed that India’s market is more complex and diverse compared to others: “India has companies in many sectors (rather than a few selected for competitive advantage), diverse consumer markets (mass production with localisation) and a large services sector (with higher employment elasticity than manufacturing). We have less concentration than Korea (where two big electronics companies are more than 20 per cent of its market cap), Taiwan (TSMC alone is 25 per cent) and Saudi Arabia (where 80 per cent of its $2.7 trillion market cap is on account of Aramco). Our biggest company Reliance equals only about six per cent of India’s market cap. Our sectors are widely distributed across financial services (at 33 per cent), technology (14 per cent), oil and gas (14 per cent), consumer goods (nine per cent), automobiles (seven per cent) and pharma (four per cent).” 

India’s 150 million demat accounts are a cushion in the event of foreign institutional investors (FIIs) hedging their bets and returning to a resurgent and cheaper Chinese market with lower P/E multiples. In fact, the opposite is likely to happen. Foreign Institutional Investors (FIIs) know that the current account deficit (CAD) in 2023-24 will be below one per cent (as predicted in this column several months ago). With the balance of payments (BoP) likely to show a surplus of $40-50 billion following India’s inclusion in the JP Morgan and Bloomberg EM bond indices, the rupee will remain relatively stable. US treasury rates will meanwhile begin their downward cycle, drawing investment towards high-growth, stable equity markets like India. 

Historically, Indian stock markets have recorded an average annual growth rate of 12-15 per cent over the last decade. What could go wrong? Barring unforeseen global events, not much can disrupt the Indian stock market’s steady rise.

Sabharwal and Agarwal relate an anecdote: “Twenty years ago, an investor told one of us, ‘India is a Mickey Mouse market, my single holding in China Mobile is worth more than my 25-stock Indian portfolio.’ 

“China’s 22 per cent MSCI weight is today only marginally higher than India’s 18 per cent. India’s qualitative market, combined with demography and democracy, positions us to overtake China in index weightage, market cap and foreign investment in about a decade.”

That’s as positive a forecast as you can get.