Morgan Stanley upgrades India to ‘Overweight’: Here’s what it means

On the other hand, Morgan Stanley downgraded China’s rating to the ‘Equal weight’ category.

Why India was upgraded?

According to the US firm, India has experienced many changes in less than a decade. These include supply-side policy reforms such as a build-up in infrastructure, formalisation of the economy via GST and IndiaStack, change in real estate regulations, digitalisation of social transfers making them leakproof, a new bankruptcy law coupled with a sharp decline in corporate balance sheet leverage, flexible inflation targeting, focus on FDI, India’s 401(k) moment, which has created a reliable domestic source of risk capital, permission to retirement funds to invest in equities, government support for corporate profits and multiyear highs on MNC sentiment.

“Manufacturing and capex are resurgent, export market share is rising, the current account is becoming more benign, consumption is undergoing radical shifts and interest rate cycles are likely to become shallower,” Morgan Stanley said.

Another factor helping growth is the likely transition in India’s income pyramid, which is likely to invert in the coming decade, leading to a few hundred million people exiting poverty, more than 100 million addition to middle-income households, and 20 million addition to rich households, it said. “Consolidation of government deficit represents a mild challenge to earnings, but more than offset by India’s improving terms of trade, which means that India will lose less earnings to firms abroad compared to the past,” Morgan Stanley said.

Is India at the start of a long wave boom?

With GDP per capita only $2,500 per capita (as against $12,700 for China) and positive demographic trends, India is arguably at the start of a long wave boom at the same time as China may be ending one, Morgan Stanley said.

“Consider that household debt/GDP in India is just 19% against 48% for China and that only 2% of Indian households have life insurance,” it said. Manufacturing and services PMIs have rallied consistently since the end of Covid restrictions in contrast to the rapid fade seen in China. As well, real estate transaction volumes and construction have broken out to the upside.

Moreover, India’s ability to leverage multipolar world dynamics is a significant advantage. It is a member of the Quad political framework with the US, Australia and Japan, it said. “It is benefitting from a surge in inward FDI, including from US, Taiwan and Japan firms looking to its own large domestic market as well as a much-improved export infrastructure situation vis-à-vis more-efficient ports, road and electricity supply. Private equity firms are expanding in India (and ASEAN) at the same time as they are struggling with exits in China,” it said.

Why China is on the backfoot?

According to Morgan Stanley, India’s future looks to a significant extent like China’s past. “Our economics team thinks trend GDP growth in China is likely to be around 3.9% to the end of the decade vs. 6.5% for India. In this context, it is particularly relevant to note long-run trends in real effective exchange rates for the Chinese yen (CNY) and the Indian rupee,“ it said.

The CNY appears to have made a major top in early 2021, and on the BIS measure has weakened by 15% in the last 18 months or so. “If this is the beginning of a tendency toward a weaker exchange rate – reflecting worsening fundamentals – we would expect profound negative implications for an equity market with almost no export earnings stocks,” it said.

Is India outperforming China?

Considering Indian equities and China equities as a pair in USD terms and using the MSCI Indices as the benchmark, the beginning of a new era of Indian outperformance compared to China appears to be dawning, Morgan Stanley said. From 2003 to 2020, the two markets performed remarkably in line with each other – both having a tendency to outperform MSCI emerging markets over the cycle.

From early 2021, however, India has broken out dramatically to the upside, having outperformed China by over 100%. “Whilst reversion to the mean is often a powerful force in finance, we think that this represents a structural break in India’s favour that warrants a bias to an ‘Overweight’ versus a bias to EW (Equal weight) or UW (Under weight) for China with the medium-term driver being significantly higher USD EPS growth and ROE over the cycle for India versus China,” it said.

Will foreign inflows rise?

Foreign portfolio investments (FPI) — which have risen of late, boosting key indices to new peaks — are expected to rise further following the Morgan Stanley upgrade. India has long-term structural interest among most investors. The prevailing narrative among global FPIs is India’s growing business and political stability, superior demographics, regulatory strength, manufacturing potential, and sovereign investor friendliness,” said Shantanu Bhargava, Managing Director, Head of Discretionary Investment Services, Waterfield Advisors.

“Over the next few years, FPIs will allocate more to India if this structural narrative remains intact, macroeconomic stability is maintained, and relative values don’t become completely irrational,” Bhargava said.

There is a high probability that India will be the fastest growing large economy in the world for many years to come. India’s demographic dividend, entrepreneurial talent, macro stability and vibrant democratic system can drive sustained high growth and consequent impressive corporate earnings. This near consensus is already baked into market valuations in India which are high compared to peers, said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

In this scenario, India is likely to attract more FPI flows than any other emerging market. Even though Indian market valuations are high in the short-term, for long-term investors, valuations are fair, he said.