2024-08-23
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In India, it seems like everyone wants to participate in the stock market. Benefiting from the demographic dividend and growing consumption, the profitability of large Indian companies is extremely high. At the same time, India is open to foreign investment, and the government's budget situation is better than it was a few years ago, with continued investment in infrastructure such as roads, railways, and even data centers.
On August 23, Herald van der Linde, head of equity strategy for Asia Pacific at HSBC, and his team released a report saying that the Indian stock market is currently hot, but there are still ten risk factors. None of these risks will pose an immediate threat, but if they come together, they may be dangerous.
For example, Indian banks have difficulty attracting deposits, private sector capital expenditure is sluggish, and foreign investment is weak and concentrated…
But Herald van der Linde added that they would continue to overweight Indian stocks because even with the risks, India has the strongest growth among emerging markets.
Indian banks have done a good job cleaning up their balance sheets over the past few years, with nonperforming assets (NPAs) falling from about 11% in 2017 to just 2.8% now. This has lowered the cost of credit and freed up funds for new lending. Many companies are eager to borrow, and Indian households are also turning to banks for personal loans to buy goods and services.
This is not a problem in itself, however, the situation has developed to the point whereCentral BankIn the past few months, Indian banks have also said they face new risks to their asset quality, particularly related to unsecured personal loans and increased personal leverage.
But this does not mean that India faces an imminent banking crisis. Abhishek Murarka, a banking analyst at HSBC Global Research, said in a report:
The size of the stressed sectors is much smaller than in previous cycles, and while credit costs have risen, they are still well below their long-term averages. In addition, bank balance sheets are much stronger. Bank risks and profits are rising, but still at low levels.
Still, it points to risks to profits in the financial sector, which together account for a third of India’s total revenue, according to FTSE India 2024 data.
Attracted by the strong returns of the past few years, it seems everyone in India is investing in the stock market.Strong investment demand makes it difficult for banks to attract deposits.
To attract deposits, banks have raised deposit rates, which has put pressure on their spreads. In addition, as loans have grown faster than deposits have flowed in, banks' credit-to-deposit ratios have risen, limiting their ability to make new loans, posing a downside risk to credit growth and negatively affecting banks' earnings growth. HSBC Global Research shows that Indian banks' earnings growth is expected to slow from 45% in 2022 to 9% in 2024.
India has increased domestic investment, and the government has launched many large-scale infrastructure plans, including ports, roads, bridges, electricity and other projects, from which local companies can benefit. In addition, the Indian government has also provided tax incentives to support these companies.
According to Pranjal Bhandari, an economist at HSBC Global Research,Investment in a key component of private capital expenditure, "machinery and equipment," has fallen, and overall private sector investment in the economy has been weak, which could pose a risk to stock market gains.
As we can see above, domestic investment in India is unbalanced, driven more by the government than the private sector. So has foreign direct investment in India increased? The answer is no, not recently.
In fact, net foreign investment in India almost halved in 2023 as divestment increased and investment fell.
Moreover, foreign investment is concentrated in specific sectors and states where it is easier to do business: Maharashtra, Karnataka and Gujarat. These three states account for nearly 70% of all foreign investment in India. This also shows that the benefits of foreign investment in the form of job opportunities in India are geographically concentrated.
Consumption in India is relatively concentrated, with urban consumers performing relatively well and rural consumers faring much worse.
This can be seen in the auto and real estate sectors. Over the past two years, rising stock markets and the availability of credit cards have had a significant impact on urban consumer sentiment. While white-collar jobs have been weak over the past year, this has not dampened demand for car upgrades among urban households. Meanwhile, in rural India, where households have not benefited from rising stock markets and lack access to bank credit or credit cards, rural consumers are unable to afford cars.
Rural Indian consumers’ spending is very much aligned with the ebb and flow of the monsoon. These households are more vulnerable to food inflation, which is running at double-digit levels in India. With onion, potato and tomato prices rising sharply across India in the past few months, these households need lower food prices, more income support, structural improvements to boost agricultural productivity and increased support to combat climate change.
One solution to India’s growing inequality in consumption is to employ more women.
The attractiveness of Indian stocks depends largely on whether earnings growth can remain strong.Herald van der Linde and his team believe that India remains the strongest growing country among emerging markets. However, India's performance in the second quarter of 2024 is worrying, with earnings growing at only double-digit rates, unlike the rapid growth in the past few years.
Herald van der Linde and his team believe the results are partly driven by seasonal factors: a heat wave in northern India and a months-long election meant consumption and investment were subdued, while weak demand from the US also affected India’s software services sector.
In our view, this could all turn around soon. Certain sectors, such as capital goods and real estate, offer good earnings visibility and could see good growth in the second half of the year; however, all this means investors need to keep a close eye on the upcoming earnings season.
Allegations regarding the governance and structure of certain Indian companies have been widely reported recently, which, if proven true, could raise concerns about governance issues in the Indian stock market more broadly.
Sudden changes in rules and regulations can adversely affect investor returns and undermine investor confidence, such as India’s retroactive increase in capital gains taxes on July 24, 2024, or its recent restrictions on the purchase of some long-term government securities.
Some risks in the Indian stock market are also related to market structure. For example, India’s weight in the emerging market and Asian index is more than 23% and could rise further, which increases market concentration risk because somefundOnly limited exposure to a single market is allowed. In short, these funds cannot buy more Indian stocks.
Another risk is that investors may have to raise funds by selling Indian stocks if they are interested in other large markets.
India is a major importer of oil and gold and a sudden rise in the prices of these commodities could pose a risk to consumer demand.
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