In recent meetings with over 50 foreign institutional investors (FIIs) across the US and Europe, UBS has noted a cautious sentiment regarding the upcoming Indian elections. While maintaining optimism about India, many equity investors are reducing their active positions, reflecting a small overweight stance.
Contrary to local expectations of a BJP single-party majority, FIIs are generally anticipating a BJP-led coalition. This sentiment is mirrored in FII equity flows, which have declined by $4 billion over the past six weeks, in contrast to the $25 billion inflow observed in FY24. Retail investors, on the other hand, have become more positive since the end of March 2024, as indicated by their options market positioning.
Despite a 9.3% year-to-date increase in MSCI India (compared to MSCI EM's 7.4%), UBS's India Composite Economic Indicator suggests that India's economic momentum remains resilient with controlled macro stability risks. However, UBS's strategy team maintains a cautious outlook on Indian equities, holding an underweight stance in the emerging markets ratings universe.
They highlight the extraordinary valuations of Indian equities—73% PE premium to emerging markets on an index-weighted basis—paired with ordinary fundamentals, with EPS growth estimates of 12.7% over the next two years, the lowest in history compared to emerging markets' 17.7%.
Foreign investors are particularly excited about India's upcoming inclusion in the JP Morgan (NYSE:JPM) GBI-EM Global Index suite from June 2024, which is expected to attract $25 billion of passive flows over ten months. UBS anticipates limited upside in bond yields due to three factors: index inclusion-related flows, expected CPI inflation falling to 3.5-4% by mid-summer, and cooling sequential credit growth, suggesting limited risks of policy-driven liquidity tightening.
The firm expects the 10-year Indian government bond yield to decline to 6.6% by the end of FY25, and contrary to market expectations of rate cuts beginning in October 2024, UBS foresees no urgency for the Monetary Policy Committee to change policy settings amid strong growth and regulatory tightening.
Looking ahead to the general election results on June 4, UBS explores three potential scenarios: a BJP single-party majority, a BJP-led coalition, and a weak coalition led by the INDIA alliance. The first two scenarios are largely priced in by the market, while the latter could imply some populist risk.
Investors are keen to know what Prime Minister Modi's immediate focus will be if elected. UBS expects the government to prioritize growth initiatives while maintaining fiscal consolidation, supported by a higher-than-expected RBI dividend transfer. The upcoming union budget may target a slightly lower fiscal deficit and continue to boost capital expenditure and consumption incentives. Implementation of consolidated labor laws and further privatization of state-owned enterprises are also anticipated to support the government's reform narrative.
UBS also highlights that while the recovery in India's capital expenditure (capex) cycle has been driven by government spending and strong demand for residential real estate, private corporate capex has lagged. This recovery is expected to gain momentum post-elections but will likely be reflected in data from FY26 onwards.
Household consumption growth is predicted to remain below trend at 4-5% YoY in FY25/26E, with urban mass-market demand expected to be modest due to softening corporate wage growth and moderating personal loan growth. However, the premium segment should perform well, and rural consumption could recover with normal monsoons, removal of agricultural export bans, and anticipated capex recovery.
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