India’s booming stock market

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Investors love a good story, and India’s economic rise is currently capturing the imagination. Last month, the market capitalisation of the National Stock Exchange of India nudged past the flagging Hong Kong Stock Exchange to become the world’s seventh-largest equity market. It neared $4tn, almost doubling in value since the start of 2020. The Nifty 50 index — a weighted average of the largest listed Indian companies — reached a record high this week too.

Previous speculation over India’s imminent take-off to superpower status has ended in several false dawns. But recently, the bullish narrative for the country’s stocks has gathered momentum as economics, geopolitics and policy have all aligned in its favour. Both institutional and retail investors have ploughed cash into its companies. While domestic investors have been the driving force, foreign equity inflows are estimated at $14bn so far this year. Initial public offerings have soared too.

The economic case for India is certainly compelling. Earlier this year, it overtook China to become the world’s most populous country. By the early 2030s, it could also have one of the largest working-age and middle-class populations. That will support its continued urbanisation and industrialisation, and drive strong consumption and investment. It has already been the world’s fastest-growing major economy in the past two years. Capital Economics expects this to continue, projecting annual growth will top 6 per cent in both 2024 and 2025.

Investors also expect the country to be a major beneficiary of geopolitical shifts. China’s slowdown has moved the “emerging market” spotlight on to its rival. And as multinationals de-risk their supply-chains amid tensions between the west and Beijing by adopting “China plus one” strategies, many expect them to choose India. Apple recently signalled intentions to expand production of iPhone components in the country.

The policy environment is favourable too. Inflation is not as severe as elsewhere and the tightening of monetary policy has not been excessive. Investment in India’s road, rail and renewable infrastructure and excitement about its tech and engineering strengths have also piqued investors. With elections next year, fund managers are betting on policy continuity. Opinion polls and recent state elections suggest Prime Minister Narendra Modi’s ruling Bharatiya Janata party is on course for a decisive victory.

A lot of the excitement is, however, now priced in to India’s stocks. The MSCI India index is trading at 20 times its 12-month forward earnings estimates — that is above its long-term average and higher than the global benchmark. Lofty valuations in the past have been followed by periods of stagnation, and several factors could punctuate the euphoria and drive corrections this time too.

The lamentable decline of India’s democracy, and rising religious tensions, could make investors hesitant to commit to the country. The country also faces challenges with corporate governance standards. Earlier this year, Hindenburg Research accused the Adani group of stock manipulation and accounting fraud, which the company denies. Further scandals could disrupt the stock market’s rise.

A sustained boom will also require greater liberalisation from a government that had tended towards economic nationalism. Foreign ownership limits on stocks makes it hard for asset managers to manage their portfolios. State-backed conglomerates and tariffs on foreign components, designed to support domestic supply chains, also makes relocation to India less attractive. And the country’s demographic dividend risks being wasted if the millions of youth entering employment cannot obtain better training and education.

Investors are increasingly buying into India’s growth story. Now they need the reality to play out as they are hoping. For that, a lot hangs on how well the country is governed — both politically and economically.