Is India’s stock market irrationally exuberant?

The past 12 months have been stellar but will the rally last amid growing uncertainties

With elections coming up in India, analysts expect Indian market to experience volatility. AFP

India’s stock market overtaking Hong Kong's market value reflects growing investor confidence in the world's most populous nation, but it also raises a more fundamental question: whether the momentum will continue.

Last week, India secured its position as the world's fourth-largest equity market. The market capitalisation of India's shares reached $4.33 trillion last Monday, compared to $4.29 trillion for Hong Kong, according to data compiled by Bloomberg.

India’s markets have the potential to scale new heights this year, as the country remains one of the world's fastest-growing major economies.

Despite that, analysts warn that stock trading in India this year is going to be characterised by volatility amid global uncertainty and imminent elections in the country.

“The outlook for India's stock markets this year appears promising due to factors including robust economic growth, continued foreign investor interest and projections of rate cuts,” says Sonam Srivastava, founder and fund manager at Wright Research, an investment advisory and portfolio management firm based in Mumbai.

“Given these favourable conditions, it's reasonable to anticipate that the Indian stock markets may explore new record highs.”

Geopolitical instability and global economic weakness are among the factors that could disrupt market stability, she says.

The world’s most populous country has a general election coming up in the next few months, which will be closely watched by investors as Prime Minister Narendra Modi bids for a rare third term in power.

“While the overall trajectory appears positive, investors should remain vigilant and be prepared for market fluctuations,” says Ms Srivastava.

India's equity markets have boomed and the factors that have fuelled the Indian market's rise include the country's robust gross domestic product growth and strong corporate balance sheets, reflecting its strategic positioning as an attractive alternative to China.

The world’s second largest economy has somewhat fallen out of favour with some investors as it is has entered an era of slower growth. Some of China's major firms are listed in Hong Kong, which has seen a historic slump in its stock market.

In contrast to the fortunes of Chinese stocks nine more Indian stocks were added in November to the MSCI Emerging Markets Index, a benchmark widely tracked by global investors.

All this has helped to attract strong foreign inflows, while domestic investor participation in Indian stock markets has also been surging.

Overseas funds invested more than $21 billion in Indian shares last year, according to Bloomberg.

India overtaking Hong Kong is therefore being viewed as a highly positive development for the country, whose bellwether S&P BSE Sensex is enjoying eight consecutive years of gains.

One Year Return of S&P BSE Sensex

“This accomplishment stands as evidence of the nation's robust economic expansion, the trust and confidence of investors, and the resilient performance of the market,” says Anil Rego, chief executive and fund manager at Right Horizons, a wealth advisory and investment management company.

He believes that India will deliver “robust annual earnings growth over the next three years, driven by a multi-decadal growth outlook for the economy, healthier corporate balance sheets, an expanding capital expenditure trend focused around infra, an increasing trend in discretionary consumption and a dependable reservoir of domestic capital”.

This year, “rate cuts globally will lead to inflows into emerging markets and India is relatively better positioned due to strong fundamentals and healthy corporate and bank balance sheets”.

Nevertheless, he expects “the near term to be driven by volatility”, with elections coming up.

“India's ascension to the position of the fourth-largest stock market in the world is a momentous achievement, signifying its growing economic prowess and attractiveness to investors,” says Ms Srivastava.

“This milestone is significant as it reflects not only India's current economic strength but also its potential for future growth.”

Asit Bhandarkar, senior fund manager, equity, at JM Financial Asset Management agrees.

“India’s growth opportunity seems robust and offers a decadal runway,” he says.

“We are confident of newer records for India along the way – although higher volatility is to be expected this year.”

That volatility in India's markets was experienced last week.

The BSE Sensex declined by about 1,000 points last week ending at 70,700.67, as IT stocks fell on weaker-than-expected earnings, while financials stocks dragged markets lower after Indian bank HDFC reported disappointing margins.

“We are in a long-term structural bull run,” says Divam Sharma, founder and fund manager at Green Portfolio. “With that being said, in the short term, we are in a fragile territory as much of the bullishness is priced in.”

He expects the next market-mover to be the country’s federal budget which will be presented on Thursday. This is the Narendra Modi government's last budget ahead of the general election, which is expected to be held by May.

“The budget will lay the groundwork for the next rally,” says Mr Sharma.

Beyond that, “we are seeing an expansion of Indian markets with many small, mid, new age businesses lining up for getting listed”, he says.

“We are also seeing a structural shift where savings are channelised more towards financial assets and the domestic participation towards markets is increasing.”

Global developments are creating further uncertainties for the Indian markets.

“Domestic macros and fundamentals are strong, FIIs [foreign institutional investors] have again started buying in the markets, and we are expecting political stability after the Lok Sabha elections,” says Mr Sharma.

“So, overall, the outlook seems positive but negative global cues might impact the Indian markets to some extent. Global inflation and recessionary trends are there and then there’s the possibility of geopolitical tensions escalating.”

While India's equity markets have been going from strength to strength, 2024 is also expected to be a pivotal year for the country's bond markets.

Global funds have already started buying into India's sovereign bonds on expectations of their inclusion in global debt indexes.

JP Morgan, the largest bank in the US, last year announced that India's local bonds will be added to its Government Bond Index-Emerging Markets from June 28. India's bond market is worth more than $2 trillion.

HSBC Asset Management, India, in a report published last week said that this development can be seen as Indian bond markets “coming of age”, and it forecasts that the move could attract $100 billion of inflows over the next three to five years.

“2024 is likely to be a pivotal year for Indian bond markets, with the inclusion of Indian Government Bonds into a global bond index for the first time,” HSBC wrote.

“Historically, this has been the first sign of strong incremental flows into the respective emerging market debt markets.”

Sovereign wealth funds, central bank reserve managers and other large institutional investors including pension funds “are likely to closely track and get more familiar with the Indian bond markets, as part of their emerging market allocations”, according to HSBC.

Overseas investors have already pumped more than 500 billion rupees ($6 billion) into index-eligible debt since JPMorgan's announcement of the inclusion, according to Bloomberg.

“The inclusion of Indian government bonds could be one of the supportive factors for domestic bonds,” says JM Financial's Mr Bhandarkar.

“We have seen that foreign flows have already started to come in the debt market ahead of the bond inclusion. This could likely develop and deepen the domestic bond markets and help in attaining a better demand-supply balance of government bonds in the next fiscal year.”

Still, Ms Srivastava warns that “the full impact on India's bond markets will depend on various factors, including global economic conditions, the relative attractiveness of Indian bonds compared to other investments, and India's management of economic policies and fiscal discipline”.

But despite such risks, India's bond and equity markets are poised to excel, she believes.

Robust economic growth, a thriving startup ecosystem driven by innovation, investor-friendly government reforms, a young and expanding population with rising incomes, and a global market realignment due to geopolitical tensions and economic uncertainties in other regions will drive growth, she says.

"These factors collectively foster confidence in India's market and make it an appealing destination for both domestic and international investors,” she adds.