India’s Stock Juggernaut

India’s stock market is a global outperformer. Its market capitalisation, at over $3.6 trillion, is now the fifth highest in the world, ahead of France ($3.2 trillion) and Britain ($3 trillion).

If the current bull market continues, India’s stock market capitalisation could in time overtake Hong Kong ($5.1 trillion) and Japan ($5.9 trillion) to become the third most highly valued stock market in the world. Only the stock exchanges of China ($10.1 trillion) and the United States ($46.7 trillion) would be in front.

Is the momentum sustainable? Stock prices are based on three fundamental factors: economic, corporate and political. Consider each. India’s macro-economy is in reasonably good shape. Tax collections are robust. The fiscal deficit is falling. The current account deficit (CAD) has dipped. Inflation is under control.  

But what’s really driving stock prices is the performance of the corporate and financial sector. Bank balance sheets have been cleaned up. Non-Performing Assets (NPAs) are down from over 11 per cent in 2014 to around three per cent in 2023. 

Corporate profitability is rising. Foreign Portfolio Investors (FPIs) who vote with their wallets see India as the clear alternative to China. Foreign Portfolio Investors have pumped over Rs 1,00,000 crore into Indian stocks so far in 2023-24. 

Retail investment is surging as well. As Sukumar Rajah, senior managing director at Franklin Templeton Emerging Markets Equity, put it: “India is an equity market with a breadth and depth of companies to invest in. On a bottom-up basis, we find a good variety of stock ideas that fit our investment philosophy: sustainable growth at a discount to intrinsic value. The long term direction of fund flows into a market depends on fundaments, including demographics and potential economic growth, as well as the risk profile of the market. For India, these factors are improving. Additionally, the Indian equity market benefits from the structural shift in domestic savings towards financial assets, such as equities.” 

Rajah’s views are echoed by US asset manager Invesco. It recently published its 11th annual edition on sovereign investment. Titled Invesco Sovereign Asset Management Study, the report noted: “India exemplifies the attributes sought by sovereign investors. We don’t have enough exposure to India or China. However, India is a better story now in terms of business and political stability. Demographics are growing fast, and they also have interesting companies, good regulation initiatives, and a very friendly environment for sovereign investors.” 

But aren’t Indian stocks high priced compared to their peers in China, the US and Europe? With a price-earnings (P/E) ratio of 23, India’s stock market is clearly among the world’s most expensive. But India also has the world’s fastest growing GDP of a major economy. Corporate earnings growth too is ahead of companies in the US, Europe, China and Southeast Asia. Investors believe a higher trajectory of corporate profit growth justifies India’s steep P/E ratios. Tax revenue from corporations is running over 15 per cent higher than during the same period last year. 

With a resilient macro-economy and strong corporate profit growth, Indian stocks will look at the third defining criterion to judge pricing: politics. India heads into four key state assembly elections later this year in Rajasthan, Madhya Pradesh, Chhattisgarh and Telangana. The Opposition is in power in three of these four states. Madhya Pradesh, which the BJP wrested from Congress through defections, could head back to Congress in the face of strong anti-incumbency against the Shivraj Singh Chouhan government. 

Meanwhile, with the festering dispute between Rajasthan Chief Minister Ashok Gehlot and dissident Sachin Pilot temporarily resolved, Congress could retain Rajasthan where the BJP’s local leadership remains lacklustre. In Chhattisgarh too, the Congress, by appointing Chief Minister Bhupesh Baghel’s rival T. S. Singh Deo as Deputy Chief Minister, has likely shut the door on BJP’s hopes for a comeback. In Telangana, the K. Chandrashekar Rao-led BRS is set to retain power for a third successive term.  

The loss of Karnataka and potentially Madhya Pradesh will weigh heavily on the BJP. Could it hamper its chances in the crucial May 2024 Lok Sabha election? Despite the formation of a 26-party Opposition front named INDIA and the tumult in Maharashtra politics, a state which sends 48 MPs to the Lok Sabha, the BJP remains favourites to win the 2024 General Election. 

The stock market has factored this in. It has also priced in the geopolitical situation with the Russia-Ukraine war having reached a grinding stalemate. Crude oil prices, crucially, remain low. 

The Reserve Bank of India (RBI), like the US Federal Reserve, has not ruled out further rate hikes to curb inflation. High interest rates over a period of time can, however, dampen industrial activity and public consumption. As Templeton’s Rajah says:  “The monetary policy stance of the Fed will continue to be a factor influencing markets in the short term. However, we believe investors will refocus on fundamentals and earnings trends among individual companies as we approach the end of the monetary policy tightening cycle.” 

In the past, Indian stocks were over-reliant on foreign portfolio investment. The sharp increase in retail investors has reduced that dependency. As on 31 March, 2023, India had 114.46 million demat accounts, up from a total of just 21 million demat accounts in 2023. In 2022-23 alone, 25 million new demat accounts were added. 

Retail investors are the bedrock on which the Indian stock market will thrive. SEBI’s shift to a T+1 settlement puts Indian stock exchanges on par with global exchanges. The growth of a robust fintech ecosystem has enabled online brokerages like Zerodha to attract six million active clients with low flat fees. Zerodha’s profit in 2021-22 of Rs. 2,094 crore, without taking venture capital or private equity funds, is a bellwether for India’s expanding equity cult.