Increased risks of persistent inflation could hit flows to EMs, including India

The market has become really volatile since it hit all-time highs. Will the rally continue through 2023?

Markets are building in expectation of slower-paced rate hikes by global central banks due to the recent moderation in inflation. This has led to the recent equity market rally. Stability is now seen in oil prices, and the global supply chain is normalizing. This could aid in softening inflation. That said, contributors to global inflationary pressures continue to persist in the form of robust retail spending, accelerating wage growth and strong monthly job gains. In addition, any spike in commodity prices led by heightened geopolitical frictions could pose a risk to the global inflation trend.

Increased risks of persistent inflation leading to rate hikes could aggravate global risk aversion, which could, in turn, impact flows to EMs, including India.

What are the things that might influence the market in 2023?

In contrast to developed markets, emerging market (EM) economies have not experienced a sharp slowdown so far. They are relatively better placed to navigate global slowdown, helped by lower inflationary pressures and reasonably resilient domestic demand. Among EMs, India is projected to grow at a faster pace than the rest of the world. Structural growth drivers include domestic orientation, improving internal demand and investment growth, opportunities from global supply chain diversification and policy measures for manufacturing and infrastructure development to induce sustainable growth. Factors displaying resilience in the domestic economy include improving high-frequency indicators in the economy and an uptrend seen in consumer confidence (RBI survey). The recent surge in forex reserves after months of decline, surplus net balance under services and remittances (scaling highs) partly offsetting trade deficit, robust net foreign direct investment flows during April-October 2022 ($22.7 billion), and resurgence in foreign portfolio flows despite challenging global environment to provide comfort are some key positives.

Near-term risks include spillover effects of the slowdown in major economies, lower export growth, strengthening dollar placing a drag on the rupee, trade deficit levels and forex reserve levels. Challenges to our present outlook could stem from another round of commodity price shock, renewed geopolitical shock aggravating supply chain disruption, stagflation driven by recession/ prolonged slowdown in major economies, and potential risk aversion in global capital markets towards EMs, including India.

What is your view on fund flows to India and market valuations?

Strong support from domestic flows through the year helped the markets despite heavy selling by FPIs. While domestic fund flows into equity funds continue to remain positive, the momentum seems to be waning in the last three months, partly attributable to present valuation levels. On the positive side, SIP flows presently scale life highs. Domestic markets trade above their historical averages and the premium commanded by the Indian market over other EMs has remained significantly above the long-period average. However, the high growth projection for India relative to other EMs attempts to justify the high valuation levels.

What are your expectations from the budget?

The budget should aim to set the government on a more prudent fiscal path and reduce the cost of capital for private investments. It should continue incentivizing manufacturing, especially in sectors with import substitution and employment generation as primary goals. The budget should also aim to harmonize taxation on individuals to ensure higher compliance and consumption recovery. Additionally, it should have improved the benefits for tax-payers for investment in housing.

Which sectors do you think will do well in 2023? Are there any underperforming sectors that might surprise us?

We continue to stay positive on domestic cyclicals, including banks, cement, consumer discretionary, realty, and materials. Due to the inherent volatility associated with global cyclicals, we choose to maintain low exposure to this segment. In addition, we expect the technology sector to be somewhat impacted by the global growth slowdown.

What are your expectations for earnings growth during the December quarter and in FY24? Will we see any upgrades to earnings estimates?

For FY23, the earning growth is expected in the mid-teens, driven by domestic cyclicals, including financial services (improving asset quality, rising credit offtake, lower provisioning) and auto (volume recovery, demand improvement, benefits of lower commodity price and operating leverage).

What is your advice to investors?

If you are an existing equity investor and have an investment horizon of over five years, you should stay invested and continue to add through systematic investment plans with a specific focus on diversified funds. However, if you are looking to allocate surplus, you may bifurcate between equity and fixed income categories based on the asset allocation recommended for your risk profile.