Indian stocks not yet strained

Comment

Indian stocks generally command a premium. Even now, as investors nervously cut their estimates for corporate earnings in emerging markets, they continue to believe companies in the South Asian nation will post reasonably healthy earnings growth.

After the recent downgrades, the stocks that make up the country’s benchmark Nifty Index are expected to generate returns around 15% higher over the next 12 months than they did at the start of 2020. That’s when expectations for emerging markets as a whole have been reduced to below pre-pandemic levels. Is this expected outperformance worth the extra price?

India’s valuation gap to other emerging markets is a “breathtaking” 3 standard deviations above the historical average, says Aditya Suresh, head of India research at Macquarie Capital. It’s not that global investors are leaning their portfolios toward China’s southern neighbor because they’re worried about the mainland’s slowing economy and growing detachment from the West. Although selling pressure has eased since July, foreign fund managers have sold more than $23 billion worth of Indian stocks so far this year.

Domestic purchases are fueling equities. Where does the funding come from? If you look at the overall picture of the banking sector, the excess liquidity that the central bank created during the pandemic years has all but disappeared. The Reserve Bank of India has raised its key rate by 1.9 percentage points since May. Yet the local stock market is still not exposed to the full force of currency restrictions.

To understand why, start with what brokerage firm HDFC Securities calls the “shifting contours of monetary transmission” in India. As of March 2020, less than 10% of rupee variable rate loans were priced against an external benchmark such as the RBI repurchase rate. By June of this year, that figure had risen to 47%. Taking advantage of rising interest rates, lenders frequently reset loan prices.

However, when it comes to paying deposits, they still hold back. Domestic equity funds have seen 19 consecutive months of inflows. This is at least partly because banks are not providing fair compensation to savers in an environment of high inflation. Take the 5.85% offered by the State Bank of India, the country’s largest commercial lender, on a five-year fixed deposit. This is when the current inflation rate is 7.4% and the Indian government pays investors between 6.3% and 7.5% to borrow from three months to 10 years.

Not only does banks’ greed towards depositors act as a source of excess market liquidity, but it also provides an outlet. With assets revaluing faster than liabilities, HDFC Bank Ltd., India’s most valuable lender, recently announced a 19% increase in net interest income in the September quarter compared to the last quarter. ‘last year. This makes investors optimistic. An index that tracks banking stocks on the Bombay Stock Exchange has returned almost 15% so far this year, compared to 2% gains – including dividends – for the local currency Nifty index.

Can the country’s banks continue to squeeze depositors in this way? Loans and advances are up 16% year-on-year as economic activity quickly normalizes to pre-pandemic levels, generating demand for credit along the way. However, system-wide deposits only increase by 9%. The divergence is largely due to currency outflows – official reserves fell by more than $100 billion from their peak in September 2021 as the RBI tried to halt the rupee’s slide against the dollar in rise.

If credit expansion continues, Indian banks may have to compete more seriously for liquidity by offering to pay better rates, indirectly creating an incentive for capital to move away from the stock market and into deposits. term. “This is the biggest risk for Indian stocks over the next year,” Macquarie’s Suresh said. To know when the tight money will finally hit the Indian stock market, investors will pay attention to fixed deposit interest rates.

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Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.

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