A positive outlook for India’s equity and bond markets

17 February 2016

2016 is setting itself up as another interesting year for India’s capital markets. Both domestic and external factors will have a large part to play in how India will fare this year. The influence of foreign capital flows and global risk appetite will continue to have an important impact on the price action of Indian assets, whilst we believe India’s underlying macro credentials mean India remains the standout economy not only in emerging markets, but arguably the globe.

Markets are seemingly fixated on global growth concerns, with China and oil both being pushed as sources of deflation. You can add the outlook for US interest rates, a strong US dollar and forced redemptions from sovereign wealth funds to the mix of uncertainty. Even against this backdrop we remain positive on the outlook for India’s economy. Global economic cycles come and go but India’s key long-term structural advantage is her demography. With a fast growing young population (the 2011 census data indicates 41% of the population is under 20 years old) not expected to peak for decades, India is essentially a domestic growth story.

Being domestically driven is certainly an advantage in the current global environment. Exports make up less than 25% of GDP, and are predominantly focused on services and not manufactured goods. Any global slowdown will have less of an impact on India and not competing directly with China is also a big positive. Indeed, China’s slowdown is, on the whole, positively impacting India via falling energy and commodity prices, as well as deflation in imported manufactured goods. Being a large net importer of oil, the low commodity price environment should help contain India’s inflation as well as the current account deficit.

Any global slowdown will have less of an impact on India and not competing directly with China is also a big positive.

The fact that we see very little risk from imported inflation leads us to believe Indian interest rates will fall further. This is in addition to the cuts we saw over 2015 that have yet to feed through into growth. Falling interest rates are obviously good news for domestic consumption and government finances, as well as a reduced cost of capital for Indian corporates. We also believe that the government will continue to make progress enacting measures to attract foreign capital and improve governance. The possible passage of the Goods and Services Tax (GST) in 2016 would make us even more optimistic on India.

Overall we remain positive on the outlook for both India’s equity and bond markets, despite a challenging 2015. Whilst equity valuations in India trade at a significant premium to other emerging markets, the growth premium that India offers is not, we believe, reflected in valuations compared to the major developed markets. We would argue that current valuations look high due to the compressed nature of domestic earnings. Turning to the bond markets, we are hopeful that with a further fall in interest rates and a steady Indian rupee, there are many opportunities in the Indian fixed income space. With regulators continuing to open up India's bond markets in a prudent fashion and increased appetite for bond financing from Indian corporates, we expect increased focus on the Indian fixed income space this year.