Why India is set for an equity boom after latest MSCI additions

Asia's third-largest economy is expected to receive an estimated $1.5 billion inflow to its stock market with new inclusions in emerging markets benchmark index

The Bombay Stock Exchange building. Indian equities have maintained an upward trend despite global economic and geopolitical headwinds. EPA

India's equity market is set to get a $1.5 billion boost with the addition of nine more stocks to the MSCI Emerging Markets Index, a benchmark tracked by investors with trillion of dollars under management.

The rise in capital flows to Indian stocks is a reflection of strong market fundamentals and growing foreign investor interest in the equity market of Asia's third-largest economy, analysts say.

“The addition to MSCI's EM Index is a significant development for India's stock markets … and is a testament to India's growing importance as an emerging market economy” says Amit Goel, co-founder and chief global strategist at Pace 360, an asset management company based in New Delhi.

Global index provider MSCI raised India's weightage in its Global Standard (Emerging Markets) Index to 16.3 per cent from 15.9 per cent on Tuesday, a move that is likely to increase the flow of foreign funds after a two-year lull.

This marks “a significant increase over the past three years, almost doubling its weight”, Abhilash Pagaria, head of Nuvama Alternative and Quantitative Research, said in note last week.

Foreign portfolio investors (FPIs), who generally use the MSCI indexes as a gauge to allocate their passive flows, have already bought 1.22 trillion Indian rupees ($14.64 billion) worth of Indian equities this year.

They sold Indian shares worth 1.4 trillion rupees and 376.32 billion rupees on a net basis in fiscal 2022 and 2023, respectively, according to a Reuters report.

The upgrade gives India the second-highest weightage on the index after China, which has about 30 per cent. The rejig is estimated to yield inflows of as much as $1.5 billion to Indian equities, Nuvama said in its note.

The emerging markets gauge by MSCI captures a selection of large and mid-cap companies from 24 emerging market nations.

The Indian equites that will be added to the index from November 30 include Tata Motors, IndusInd Bank, Suzlon Energy and One 97 Communications, the parent company of digital payments platform Paytm.

With new additions and no deletion of Indian companies in the review means that India will have 131 companies on the index – the most the nation has had on the gauge.

“It reflects a global acknowledgement of these companies, potentially leading to substantial foreign investment,” says Suman Bannerjee, chief investment officer of Hedonova, a hedge fund investing in alternative assets.

The move reflects “the growing validation of the India story”, says Amar Ambani, group president and head of institutional equities at YES Securities India.

“The interesting part is that the pace of additions is larger than every other emerging market, barring China,” he said.

On offer from India for foreign investors is a selection of businesses that give them access to a wide range of sectors of in one the fastest-growing economies in the world. That certainly is a factor helping to attract their interest, he adds.

The country, which is the world's fifth-largest economy, is expected to overtake Japan to become the world's third-biggest economy by 2030 with a gross domestic product of $7.3 trillion, according to S&P Global Market Intelligence.

India's equities are part of the country's growth story and analysts say that the impact of the nine stocks joining the MSCI index should not be underestimated.

MSCI indexes are widely used as benchmarks by passive investment funds, including exchange-traded funds (ETFs) and other index-tracking investment vehicles, says Narendra Solanki, head of Mumbai-based research at Anand Rathi Shares and Stock Brokers.

“These indexes are designed to represent the performance of the equity markets in various regions or countries, and they serve as important benchmarks for investors to measure the performance of their portfolios against.”

Any changes in the constituent stocks of the MSCI Global Standard Indexes or adjustments in their weight can have a significant impact on the composition of passive portfolios, he adds.

“For example, if a stock is added to the index, passive funds that track the index will need to buy that stock to maintain alignment with the index [parameters],” he says. “Conversely, if a stock is removed from the index, funds will sell that stock.”

“Changes are often anticipated by the market” and this often results in significant trading of those equities ahead of the actual inclusion, Mr Solanki says.

The positive impact of post and pre-inclusion trading can also be felt across the market.

“The addition of Indian stocks to the MSCI Index can contribute to overall market bullishness, as it signals confidence in the Indian market from international investors,” says Mr Solanki.

“This positive sentiment can attract more foreign capital [from active investors] and boost the valuations of other stocks in the market.”

Indian stock markets have rallied this year, hitting record highs in September. They did, however, suffer a setback in recent weeks, driven by elevated US Treasury yields, investor sentiment souring globally amid the Israel-Gaza war and concerns about overvaluation of Indian equities.

In the past two weeks, the market has recovered some of the lost ground, with the benchmark BSE Sensex on Friday closing at 65,794.73. It is still off its all-time high of 67,927.23, which it touched in mid-September.

The index is up 7.56 per cent since the start of this year, a stronger performance than some of the other major markets, including London's FTSE 100, which is down 0.66 per cent year-to-date, and the Shanghai Composite Index, which has fallen 1.99 per cent this year.

The country's strong economic growth momentum is big lure for global investors, Mr Goel says, adding that the recent lull in the equities market is only temporary, and that the outlook remains bright.

“FIIs have been net sellers in the Indian market since August but we expect positive inflows over next four to six weeks as the macro backdrop has improved significantly since October end,” he says.

“The Nifty [the flagship index on the National Stock Exchange] possibly touching a new all-time high in December.”

The country is also benefiting as “challenges faced by Chinese economy and concern over its recovery” have diverted some of the global foreign investment towards India, Mr Solanki says.

The MSCI China Index is down by 9 per cent this year, while the MSCI India gauge has risen and is poised for its fifth annual gain in 2023, according to Bloomberg.

The Indian benchmark has maintained the upwards trajectory despite headwinds.

“Given the Israel-Hamas conflict, adding to existing headwinds of high interest rates and China deflation, the sentiment globally has been lukewarm,” says Mr Ambani.

“FIIs have sold emerging market equities in recent times and India was no exception,” he says. “Having said that, overall FII flows into Indian stocks have been positive in 2023.”

Global funds have injected more than $12 billion into Indian equities in 2023 so far, Bloomberg reports.

“As for the outlook, I think it appears optimistic for Indian equities,” Mr Bannerjee says.

“The attention from global indices, particularly MSCI, and the projected inflows into specific stocks reflect confidence in India's economic and market potential.”

It is, however, essential to “exercise caution and monitor external factors” including global economic conditions, geopolitical developments as well as and domestic policy changes, he adds.

There is “growing confidence” and that “our sense is that India’s footing will further strengthen in the index”, driven by its well-rounded opportunity compared to other heavyweights in the index such as China and Taiwan, says Manish Chowdhury, head of research at broker StoxBox.

Foreign investors are encouraged by India's “proactive government measures, improved corporate earnings visibility, better fiscal and monetary policy management, and a growing opportunity”, Mr Chowdhury adds.