What’s next for Indian equities following the recent pullback?

India’s economy is experiencing a bit of a slowdown which has taken the shine off the local stock market. The Nifty 50 Index is around 10% off the peak reached in September last year – albeit after a 267% total return from covid-era lows.¹

Despite the near-term cyclical headwinds, we believe that Indian equities are a good long-term structural story, as the country soon becomes the world’s biggest driver of growth.

Some headwinds on economic growth

Economic growth in India has recently faced some headwinds: slowing household consumption especially in the urban areas. Wages have stagnated and dragged down household balance sheets.

India’s big consumer goods companies have reported softer earnings in previous quarters. But easing food inflation could take some of the pressure which may explain why rural consumption has started to pick up.

The current quarter is likely to show a modest recovery in growth led by the industrial side of the economy.

Government announced policies to boost up growth

To be sure, policymakers are attuned to issues in the economy. Two key policy events unfolded in February that provided some clues as to how the government plans to boost up growth.

First, Prime Minister Modi’s government presented its full-year budget announcing INR 1 trillion (USD $11.5 billion) in tax relief for the middle class,² which should help to prop up urban disposable income and in turn spur consumption.

Second, The Reserve Bank of India (RBI) cut the policy rate by 25 bps to 6.25%, marking the first-rate reduction in five years (since May 2020).³

The Monetary Policy Committee (MPC) opted to maintain a neutral monetary policy stance and suggested that encouraging disinflationary dynamics likely opens the door for more measures to support growth.

The RBI expects inflation of 4.2% and GDP growth to accelerate to 6.7% for the fiscal year.⁴

Outlook

One key risk is that India could be exposed to Trump’s “reciprocal tariff” policy. 

But the good news is that India relies less on exports to the US when compares to other major Asian economies and most of its exports are services, which make up roughly 10% of GDP today, far higher than the 7% pre-pandemic.⁵

Longer term, India will need to liberalize more industries in order to attract higher FDI flows.

This should strengthen a burgeoning manufacturing sector and unlock higher trend growth and generate more higher paying jobs.

We believe that Indian stocks are likely to start working again once the cyclical growth headwinds start to abate and corporate earnings exceed expectations.

And there’s good reason to think that growth dynamics are likely to improve shortly. The confluence of monetary easing coupled with improved fiscal spending should uplift growth in the coming months.

Already, high frequency indicators are showing some green shoots.

For example, the manufacturing PMI edged up to a 6-month high of 57.7 in Jan on the back of higher export orders and central government capex rose by 95.3% y/y to INR1.7 trillion in December.⁶

This uptick in government spending suggests the groundwork has been laid for growth to push higher very soon. 

Indian stocks have for a very long time, been expensive. But high valuations are less of a concern as historical precedence suggests that investors pay up for growth – and India is the only major economy that will see growth meaningfully accelerate in the coming years. 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.