The case for investment into Indian markets remains very strong. We are in the midst of new growth cycle and the earnings for the financial year that just went by have beaten almost everyone’s expectations. Despite persistent inflation over the last four of five months and the resulting rise in input costs, the profit growth for the quarter that went by has looked good. For Q4 we’ve had a profit growth of above 20% for any type of stock market cohort, be it Sensex, nifty, BSE 500, Smallcap, Midcap etc. In the short term however we’re of the view that the Indian stock market could be range bound with a probability of lower levels.

In order to give you a perspective on where we are currently in terms of economy and markets, lets take a step back and review our path to this current phase. Where we are currently,  specifically with regards to Indian markets & economy , needs to be explained in two parts:

First is the Indian govt shift of policy towards boosting profit share of GDP of corporate India to boost private investment during the end of 2019. This was a period that was preceded by several quarters of declining growth. The seminal event that marked this policy shift was corporate tax rate cuts of September 2019. Growth equals to investment divided by efficiency, and it was clear that to create sustainable growth we had to boost private investments. Our administration has since been a supply side administration that is focused on boosting profits as a share of GDP in the hope of inducing private investment. Profit share as a ratio to GDP was 1.5% during September 2019, and it’s currently approximately 4%. It is infact this powerful force that has given legs to the rise in corporate profitability and the stock markets. And it’s this reason that we think of this period for markets, could be similar to that as the famous 2003 to 2007 period. Just to give you perspective, the Vajpayee govt left office in 2004 a year in which the profit share to GDP was 8%. This also led to the bull run of 2003 to 2007.

The second factor that needs to be understood is in the context of the formula or the tools used by policy makers to start a new economic cycle post the initial Covid lock-downs. We were in a period of low interest rates, huge quantitative easing, massive govt spending and low oil prices. These factors have always historically provided a boost to the economy and it’s been no different this time around. The side effect of lowering rates & increasing money supply is inflation. In our current case as well, inflation has come back very strongly. More strongly that people initially expected because the issue of supply chains have persisted much longer than initially expected mainly due to the Russia/Ukraine conflict and the bouts of Covid in China combined with its zero Covid policy. This combined with the policy of most large economies to put money in the hands of people to ease the Covid pain has meant inflation much higher than the comfort zone.  India during this period chose to be unique in its approach in the sense that we resisted putting money in the hands of people the way other economies did.

This brings us to where we are now. Multi decade high inflation around the world means that all administrations will now prioritize controlling inflation over boosting growth. We are entering a period where low interest rates & increase in money supply will be rolled back. Oil prices have reached all time highs. Here one needs to bear in mind that India is very differently positioned from the rest of the world. This is manly due to our administration’s policy of remaining predominantly supply side focused through-out the pandemic. This has meant that India inflation is closer comfort zone compared to most other large economies. Let’s take the US for example where consumer inflation is at 8% with a central bank policy to limit inflation at 2%. India’s inflation target is 4% to 6% and inflation in April was 7.8 %. This compared to the US, where inflation is at its highest in the last 5 decades and 4 times its comfort zone of 2%, looks much better. This also means that India’s policies to control inflation will have to be less damaging to growth as compared to what  many other large economies will have to do to control inflation.

India’s GDP growth during the last financial year has been estimated to be upwards of 8.5%. This makes India comfortably the fastest growing large economy in then world. Most economic agencies expect the Indian economy to be grow at around 7% in the coming fiscal. This would again make India the fastest growing major economy. Although India is not insulated from the slowdown in global growth, it is likely to continue as the fastest growing major economy this year as well. Foreign exchange reserves are strong. Performance on exports and FDI continues to be robust. Tax collections remain buoyant, credit off-take is picking up and green shoots of private investments are becoming visible. We suspect that the profit share of corporates as a ratio of the GDP should continue to grow. Our view is that this figure, by 2025, could be somewhere close to 7%. In the coming fiscal we’ll probably have an earnings growth in the late teens, despite a stronger base and margin pressures due to higher input cost.

So doesn’t this mean Indian markets should be doing well?  While we do think Indian markets will make returns in the medium term, it is likely to be range bound be with a negative bias in the short run. There are a bunch of negative factors that are likely to affect our markets. We have the Russia Ukraine conflict & ongoing bouts of Covid in China that continues to hamper the revival of broken supply chains. We have the possibilities of a US & European recession that has causing a huge global risk-off trade and thereby a massive foreign money outflow from India and all markets fo that matter. And finally we have the revision of growth in India itself due to inflation. All these powerful factors mean that the markets are likely to be at best range bound in the near term and maybe even search for lower levels to price in some of these impeding factors.

From Russia comes the risk that we have a much higher fertilizer subsidy. The govt is already budgeting for more but if the war doesn’t end soon then we may have to spend resources on this for much longer. It’s very difficult for us to tolerate higher fertilizer prices as that leads to higher food prices and hence higher inflation.

Oil is another risk we are all aware of. Rise in oil prices can also be severe on India’s balance of payments & cause inflation to go up. Crude oil approximately accounts for about 20 per cent of India’s total imports. Due to the inelastic nature of its demand, an increase in crude prices invariably leads to higher import bills for the country. A 10 per cent increase in crude oil will lead to an increase in the Wholesale Price Index (WPI) in India by nearly 0.9 per cent. Both the factors put a lot of pressure on our currency.

In the short run we expect markets to be very much in sync with our new reality of rising rates, monetary tightening, rising subsidy costs, high oil prices &  the possible onset of several large economies. The thing is all of these factors affecting us currently are all cyclical.

The prospect of lower global growth has always caused oil prices to come down.  Infact the burden of higher rates will also have a bearish sentiment for the oil market. The resolution of the Russia war will also strongly impact oil prices negatively. Rates may continue to rise for a while but will stop doing so probably by the end of the this calendar year. It is very unlikely that in India higher rates, pre Covid rates of even marginally higher, will damage growth. This leans us to believe that once these cyclical & external negatives for the markets will blow over and a strong bull case for India will resume.

We’re still optimistic about the one year to eighteen month outlook. We still characterise this as a bull market. This is a correction in a multi year bull market. This seems something similar to 2004 when the federal reserve inflected its rate cycle. We still feel that the current situation in India  has many similarities as the 2003 to 2007 period, with the exception of the unprecedented debt burden that economies around the world currently are in. We believe that once the dust settles on this current bout of market correction we will see a bull market resume.