India's long-term equity story remains strong, says Morgan Stanley MD | Stock market | BFSI Summit

Summary

The discussion highlights India's evolving economic landscape, with an emphasis on strong corporate earnings growth, increasing capital expenditure, and an improved investment climate. Despite challenges such as low capacity utilization and competition from global AI investments, the outlook for India remains positive. Key factors include policy shifts, domestic demand, and a narrowing valuation gap with China. While foreign investments were deterred by relative growth dynamics and AI trends, the speaker anticipates a stronger foreign capital inflow as corporate issuances increase and valuations stabilize. India’s growth cycle is positioned for substantial recovery in the coming years.

Takeaways

• 😀 The Reserve Bank of India (RBI) made a rare, unexpected double interest rate cut in April 2025, signaling a shift in its economic approach and providing a boost to the growth outlook.
• 😀 This rate cut is unique, only occurring twice in the last 25 years—once during the global financial crisis and now, during a non-crisis period, indicating a significant change in the RBI's strategy.
• 😀 India’s corporate earnings are projected to grow strongly in the next few years, with an expected annual growth rate of 15-20% as corporate earnings as a share of GDP rise from 5% to 9%.
• 😀 The capacity utilization in India is currently in the high 70s but is expected to rise into the 80s, suggesting an increase in industrial activity and corporate investment (capex).
• 😀 Private sector capital expenditure (capex) is already at 31% of GDP, and it is expected to rise further, though it is unlikely to reach the previous cycle peak of 39%.
• 😀 Improved productivity in India over the last 15 years means that the economy now requires less capital for every unit of growth, reducing the need for huge increases in capex.
• 😀 The nature of capital expenditures is also shifting. Tech companies, for example, invest in intangible assets like software and platforms, which aren’t capitalized on balance sheets but still contribute to long-term revenue generation.
• 😀 Foreign institutional investors (FII) have been hesitant to invest in India recently, largely due to technical market dynamics, where domestic bids have outpaced corporate issuances, leading to foreign selling.
• 😀 Another factor holding back FII investments has been the relative growth cycle between India and other countries like China. While India’s economy was slowing, China was stimulating its economy, making it a more attractive option for foreign investors.
• 😀 India’s AI sector is underdeveloped compared to other countries like China, the US, and Korea, which have seen significant investments in AI-related industries. This lack of an 'AI trade' has deterred some foreign investors.
• 😀 India's valuation compared to other emerging markets has improved, with its valuation narrowing from 20x earnings last year to a more reasonable level. This could make India more attractive to foreign investors in the near future.

Q & A

What was the significance of the Reserve Bank of India's (RBI) interest rate cuts in 2024?

The RBI’s interest rate cuts in 2024, particularly the unexpected double rate cut in April, signified a shift in the RBI's approach. Such cuts had only been seen during crises like the Global Financial Crisis or the COVID-19 pandemic. The decision to cut rates without a crisis indicated a more accommodative stance aimed at supporting economic growth.

How does the RBI's policy change set the stage for strong growth in India?

The RBI's shift toward lower interest rates, coupled with deregulation, signals a more favorable business environment. These factors, combined with the government’s GST rate cuts in September 2024, are expected to stimulate economic activity and contribute to strong growth in the coming years.

What is the expected trajectory for corporate earnings in India over the next few years?

Corporate earnings in India are expected to grow significantly over the next few years. The share of earnings in GDP is projected to rise from 5% to around 7-9% within the next 4-5 years. This would translate to earnings growth of 15-20%, driven by strong nominal GDP growth.

What is the current state of capacity utilization in India, and how is it expected to change?

Capacity utilization in India is currently in the high 70s, but with strong nominal growth, it is expected to rise into the 80s over the next few years. This will likely lead to increased investments in capital expenditure (capex) to meet the growing demand.

Why is the current private capital expenditure to GDP ratio considered high, and what is the outlook for this ratio?

India’s current private capex to GDP ratio is over 31%, which is relatively high. However, it is expected to increase slightly over the next 3-4 years, potentially reaching 35-36%, driven by improvements in productivity and changes in the nature of capital expenditures.

How have changes in productivity affected the need for capital in India’s growth?

India’s productivity has significantly improved over the last 15 years, meaning that less capital is required for every unit of growth. This change reduces the amount of capital needed compared to previous cycles, which is why the next cycle’s peak in capital expenditure is unlikely to match the previous high of 39%.

What are the main reasons foreign investors have been hesitant to invest in India recently?

Foreign investors have been cautious about India for several reasons: first, there’s been a strong domestic bid in the market, requiring foreign investors to sell; second, India’s economic growth was slow compared to China, which was stimulating its economy; and third, the global focus on AI investments has not led to a major AI-related boom in India.

How does the relative valuation of India compare to other markets, particularly China?

India’s stock market was trading at a premium compared to emerging markets (EM) and China in 2024, with a price-to-earnings ratio of around 20x compared to China’s 9x. However, by late 2024, China’s valuation had increased to 16x, and India’s valuation remained around 20x, narrowing the gap. Despite this, India is still considered to have terminal growth potential, while China’s growth is seen as slowing.

What is the outlook for foreign direct investment (FDI) in India over the next 12 months?

FDI in India is expected to increase over the next 12 months as the factors that previously held back foreign investment—such as technical market conditions and concerns over India’s relative economic growth compared to China—begin to improve. Corporate issuances are expected to rise, which will accommodate greater foreign investment.

What is the key technical factor that impacts foreign investment in the Indian stock market?

The key technical factor impacting foreign investment is the dominance of the domestic bid in the market. If corporate issuances do not exceed the domestic demand, foreign investors are forced to sell, creating a technical barrier. However, as corporate issuances are expected to increase, this will help attract more foreign investment.