Welcome to our fourth post on Indian Financial Markets as a part of our knowledge series on “Is India the new China?”
The events in capital markets determine any economy’s global standing. Therefore, looking at the health of Indian capital markets is crucial to determine its ability to compete against China and other global players.
Bonds:
Considering the popularity of the government bonds, Indian local currency bond market is not dominated by the corporate's. The corporate bond market in India is smaller than that in other developed economies including China.
The local currency bonds that are quota-based have seen subdues demand trends and the offshore INR bonds or Masala bonds which are not quota-based have not been priced at very attractive prices.
The Indian Government has resisted completely liberalizing the bond markets for the foreign investors who play key role in improving the bond markets condition, but the measures included in Budegt-2020 encourage such foreign participation. Hence the bond market is expected to grow gradually in next five years.
India’s plans of its inaugural sovereign bond issue in 2020 were disrupted due to the pandemic which is expected to be executed in the next five years. This would improve India’s bond market growth and representation in global markets and indexes.
After a few flat years during the global financial crisis, India’s High yield (HY) segment has grown in recent years. Even though, due to the challenges posed by external commercial borrowings controls set by the Central Bank the segment is expected to grow at a slower phase than the other segments, the defaults would be very low on the back of better-rated investors in this segment.
Equities:
Earnings from the NIFTY index are not purely based on India’s domestic affairs as almost 25% of the index’s market cap relies upon the global events. This is because India’s large corporates have significant dependence on sales outside India, foreign JVs and Fuel.
Indian business sectors are up for a few intriguing structural changes such as growth in the levels of privatization of PSUs from strategic sectors such as financials, energy, power, defense etc., and increasing formalization in the industries such as paints and jewelry.
These changes may lead to changes in the composition of the NIFTY index & may impact weight-allocation of the sectors therein.
According to the experts the Indian equity market would triple from its current size over the next decade based on conservation assumptions such as based on the historical trends NIFTY has outgrown India’s nominal GDP 1.2 times. The combined estimated growth rate for the next decade is expected to be around 11.5%.
Depreciation of Indian Rupee:
The INR has lost its value from 42 to 76 against a dollar, over past two decades amounting to 44% loss of value. This combined with the interest rates advantage, the INR has attracted USD based investors & investors seeking yield in a low interest rate environment.
The two factors driving the valuation of INR are higher inflation & current account dynamics.
Inflation in India, which was stable at mid-single-digit levels from 1999 to 2004, accelerated between 2005 and 2013 to high single digit/double digits. This period of high inflation weighed on the Indian rupee, as reflected by the INR nominal effective exchange rate. The rupee was fairly stable from 2001 to 2004 when the Indian economy registered a current account surplus. But it started to slide steadily with deteriorating current account situation in 2005.
The RBI formalized an inflation-targeting regime under then Governor Raghuram Rajan (2013-2016), and the inflation was brought back under control and the rupee stabilized. Also, improvement in India’s current account dynamics since 2013, helped by a more prudent monetary policy and lower oil prices, resulted in the stability of the INR.
In addition to the above-mentioned two factors, even capital account flows will drive the INR in the years ahead. Considering the positive outlook from these three factors the rupee’s outlook for the decade ahead is optimistic. Also, the rupee would get help from India’s efforts to gear up as a regional manufacturing hub amid shifting global supply chains, as well as the further opening up of India’s financial markets to foreign investment.
Conclusion
If the value of INR is successfully stabilized and door in the capital markets are opened up more systematically, India’s attractiveness amongst investors would increase significantly over the upcoming decade, which would contribute towards helping India strengthening its position as a market leader in various segments against China.
Source : UBS