‘India’s expensive valuations, sharp rupee depreciation key concerns’

India’s valuations are expensive but could see a contraction if global risks rise further, says Amish Shah, head of India Research, BofA Securities. In an interview with Ashley Coutinho, he says valuations for the Nifty are closer to its long-term average, and a revival in China could pose a challenge as India has continued to gain weight within the EM index over the past two years, even as China’s weight has contracted. Edited excerpts:

The MSCI India has outperformed the MSCI EM by a wide margin this year. Does this signal a decoupling of sorts?

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Indian equities seem to be richly valued. What is your take on valuations?

India’s expensive valuations and the recent sharp rupee depreciation are key concerns. Valuations could see a contraction, particularly if global risks (such as Fed hikes and geopolitical issues) rise further. We believe that valuations for the Nifty are closer to its long-term average, when seen based on weighted average valuation of the Nifty’s current constituents. India’s valuations are, however, very expensive when compared to EMs. Revival in China is hence a risk, especially since India has continued to gain weight within the EM index over the past two years, while China’s weight has contracted.

Which sectors are you betting on?

We continue to favour domestic cyclicals such as financials, industrials and cement for their higher earnings visibility and valuation comfort, and defensives such as utilities, healthcare and staples as a hedge against market volatility. We continue to be underweight on external-facing sectors like IT, materials, energy and communication services, on higher capex due to 5G rollout and consumer discretionary, given steep valuations.

What is your take on Fed hikes?

Over recent years, global monetary policies, particularly those of the US Fed, have been the single most important driver of equity markets globally, including India. That’s unlikely to change any time soon. The correction seen in global equities this year is nothing but largely the markets factoring in these higher rates.

Our US economists expect the Fed to raise its policy rate by 75 basis points in November and 50 bps in December, followed by two 25 bps rate hikes in February and March next year. This would bring our new forecast for the terminal target range for the funds rate to 4.75-5%. But inflation moderating at a rate slower than expected could imply faster tightening and remains a risk to an already slowing growth outlook.

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What is your outlook on FPI flows?

Flows will be mostly driven by global macro risks, including the unfolding currency risks and spike in crude prices. This is also evident from the kind of funds driving the selling: Active FPI funds saw outflows of $1.3 billion in September, while passive funds ($418 million) continued to remain positive.

Domestic institutional investors (DIIs) and retail investors have been net buyers this year. Do you expect this trend to continue?

SIPs have remained robust at more than Rs 10,000 crore for the past 13 consecutive months. Our analysis of data over the past two decades suggests there have been limited outflows from equities in favour of debt investments, even at very high G-sec yields of 9% plus. So, the risk of DIIs and retail flows reversing soon seems limited as of now. We would watch out for trends on this issue, as bank FD rates continue to expand responding to shrinking system liquidity.

What are your expectations from the September quarter?

We expect the September quarter to post modest earnings growth at 12% YoY for the Nifty, especially given that it’s a seasonally weak quarter, with activity subdued in various sectors due to the monsoons. Overall, we expect margins to start bottoming out from here on as higher cost inventory gets flushed out. We expect margins to expand in H2FY23. For FY23, we see modest earnings growth for the Nifty at 12%. However, we do see risk to consensus earnings growth estimate at 16% for FY24. Global growth slowdown as well as India-specific risks (crude, currency) could act as catalysts for earnings cuts.

What is your view on the private capex cycle?

With Covid uncertainties largely behind, we expect private capex to pick up in a year or so. More importantly, we think the government breaking large infra monopolies is creating an ideal set-up for revival in private capex. Historically, this has played out in sectors like roads, power generation, transmission and now we are seeing monopolies being broken up or sectors being opened up for private participation in city gas distribution, commercial coal mining, airports, defence production and railways, among others. Further, shifting of global supply chains away from China could also drive manufacturing capex in India. To complement these supply chain shifts, the government has undertaken a massive overhaul of the logistics network in the country including highways, freight corridors, inland water transports and multimodal logistics parks, which will again drive huge infra capex going ahead.

What is your take on banking and NBFC stocks?

We are positive on the financials space. Earnings of large banks, which have announced results so far, support our positive bias. Credit growth in the mid-teens is close to record highs, while we have also seen margin expansion in most cases. Management commentaries also suggest cautious optimism on the growth outlook. We think incrementally, the focus will keep shifting on the liabilities side, and hence larger franchises having structural advantages on this front could continue to do well.