It is said that over a longer period, equity markets (stock prices) are slaves of earnings, and Indian markets are a shining example of that phenomenon. Since financial year (FY) 2020 (March end), earnings growth of NSE 500 companies has been 26 per cent CAGR (FY 20-24), and at the same time, equity markets (NSE 500 index) have compounded by 32 per cent CAGR.
So, what has led to this phenomenal earnings growth? To understand this, we need to go back to the decade of the 2010s, which can be classified as the lost decade for India Inc’s profitability.
A tale of two decades
During FY2008-2020, the EPS of Nifty 50 companies compounded by just 5.1 per cent, which was significantly lower than the nominal GDP growth, which averaged at low double-digit growth. Questions arise as to what led to this abysmal corporate earnings growth? There are two prominent reasons for that: Post the global financial crisis, to boost growth, the government announced huge infrastructure projects, and the banking sector significantly increased their corporate lending book between 2009 and 2012, which led to a big credit cycle (NPA) over the next five to six years.
Secondly, post-2014, when the new Modi-led NDA government came into power, they unleashed a lot of structural reforms like Jan Dhan Yojna in 2014, where Jan Dhan-Aadhar-Mobile Trinity (JAM) aimed to connect every household with the banking system digitally. Insolvency and Bankruptcy Code in 2016 looked at resolving India’s bad debt problem by creating a database of defaulters, while demonetisation in 2016 helped curb black money in the country. Meanwhile, Real Estate Regulatory Authority in 2016 was initiated to improve transparency in the real estate market and encourage more investment in the sector, and finally, the Goods and Service Tax in 2017 was introduced to consolidate all indirect taxes into One Nation, One Market, One Tax.
While the above reforms are structurally good from a long-term perspective, they impacted the growth of corporates in the short term. This, along with higher slippages (NPAs) in the banking system, impacted the overall corporate profitability. Once the economy got adjusted to new reforms and got stress-tested during the Covid-19 crisis, the lollapalooza effect came into play – India started the 2020 decade with a strong balance sheet not only of corporates, when corporate leverage was at a decadal low, but also the banking system and the household sector.
The transformational reforms, which laid the foundation for strong economic growth, coupled with the manufacturing and capex push by the Modi-led government – with its Make in India, production-linked incentives in certain manufacturing sectors, and cut in the corporate tax rate – set the earnings flywheel into motion.
In the past four years (FY20-24), the EPS growth for Nifty 50, Midcap index and NSE 500 has been 20 per cent, 30 per cent, and 26 per cent respectively, which in turn has led to 29 per cent, 44 per cent, and 32 per cent CAGR in the respective stock indices. We believe that in the medium term, India Inc’s earnings growth will be higher than the nominal GDP growth.
Over the past 10 years, India’s GDP has grown by 7 per cent CAGR to $3.6 trillion (Dh13.22 trillion), jumping from the eighth-largest to the fifth-largest economy. As per various international agencies, over the next four years, India’s GDP will likely touch $5 trillion, making it the third-largest economy by 2027, overtaking Japan and Germany, being the fastest-growing large economy with the tailwinds of demographics (consistent labour supply), improving institutional strength and improvement in governance.
Other macro factors such as improving twin deficits, fiscal and current account deficit, strengthening forex reserves and stablilising currency, which can be further aided by increasing flows post inclusion of India in the Global Bond Index, and a benign inflationary environment can further add to the positives.
India’s 401(k) moment
Apart from the strong earnings growth, another important cog in the Indian stock market wheel is the emergence of the Indian domestic investor class by way of Systematic Investment Plan (SIPs) and retirement funds. SIPs are essentially monthly investments that are auto-debited from bank accounts into designated mutual funds. As of June 2024, there were nearly 90 million such SIP accounts, contributing $2.5billion of monthly inflows to the Indian equity markets.
India’s 401(k) moment has created a reliable domestic source of risk capital.
The consistent domestic flows have thus served to counter the more volatile FII flows, which may move on multiple external factors as well as Indian local attractiveness. For example, during the recent mid-’22 sell-off in emerging market equities, the flows into domestic MFs, trailing 12 months, at over $30 billion, matched the similar $30-billion outflow from the FPIs, keeping the market corrections shallow and making India a relatively consistent performer.
India’s 401(k) moment has created a reliable domestic source of risk capital. Households remain less exposed to equities relative to other asset classes, and we see the domestic bid on stocks being sustained for a long time, as it was in the US from 1980 – when 401(k) plans were allowed to invest in stocks – to 2000. Domestic flows into US equities surged in those two decades.
Potential risks
While there are plenty of positives on the macros and the domestic equity story, one must be mindful of the potential risks to the India growth story. The country faces capacity constraints in the bureaucracy, the judiciary and skills training. There are also other risks including geopolitics, AI’s effects on the tech industry, low productivity in the farm sector and climate change. A substantial global growth slowdown can hurt India’s growth as well as funding.
Cautiously optimistic
Going ahead, India is likely to drive a fifth of the global growth in the coming decade. This will be underpinned by increased offshoring of both services and goods, leading to a manufacturing boom, as well as energy transition and the country’s advanced digital infrastructure.
India’s market cap has now surpassed $5-trillion mark and it ranks fourth in the world. Indian equity markets have been able to generate consistent 10 per cent annual returns in US dollar terms over the past 5/10/15/20-year periods: much better than any of its global peers in the emerging market space. With a renewed capex cycle and robust earnings profile, Indian equity markets can continue to deliver 8-10 per cent dollar returns over the next five to seven years. Structural domestic flows arising from the shift of savings to equities and potential listings of large unicorns in India can drive the market cap past $10 trillion by 2030-32.
The writer is Head, Equity Investment and Strategy, Julius Baer India
