Cautious on India despite looming liquidity tailwind: UBS' Sunil Tirumalai

A softer-than-expected inflation reading in the US could lead to a global liquidity tailwind next year, but UBS is still cautious on India. SUNIL TIRUMALAI, strategist, UBS Securities India, says India’s high valuations and a depreciating rupee could act as headwinds for the domestic markets. In conversation with Samie Modak, Tirumalai says the reopening of China and rising domestic deposit rates could dim the appeal for equity markets. Edited excerpts:

What are the key underlying factors behind India’s outperformance over the past year?
 

Year-to-date (YTD), India has outperformed emerging markets (EMs) by 20 per cent (India is down 5 per cent, while the EM index is down 25 per cent).

There is a narrative that in the present-day scenario of heightened economic, political, and geopolitical uncertainty, India is still seen as a country with a relatively better outlook. This has driven its valuations up. However, we do not see data supporting this.

YTD, foreign portfolio investor (FPI) selling in India has been quite intense and is second only to Taiwan.

In reality, the key reason for this steady outperformance over the past 12-18 months has been strong inflows into markets by households – both through mutual funds and directly in the stock market.

In a context of low deposit rates, households have been channelling their excess savings from the lockdowns into markets.

Will India continue to outperform? Can strong domestic liquidity be sustained?

India’s valuations currently stand at about 100 per cent premium to EMs on a 12-month forward price-to-earnings basis – that is a 3.7 standard deviation from the historical mean. This premium is broad-based, with 17 of the 21 sectors trading at a premium relative to their history.

These record valuations are, in my view, an artifact of very high household flows into the market.

We see two key risks for this trend to persist. One, with the unlocking of the economy, avenues for households to spend on have increased, reducing excess savings. Two, bank deposits are traditionally a staple savings instrument for households. 

Deposit rates are lagging behind other rates in the economy at present. With credit growth outpacing deposit growth, we expect deposit rates to rise further as well.

The rise of bank deposit rates could cause household savings patterns to shift from markets towards traditional instruments like deposits. Any signs of interest waning could trigger a derating of stocks.

How does the latest inflation reading in the US alter the situation?

The UBS global economic view is for the US Federal Reserve to remain restrictive till mid-2023 and then pivot sharply in the face of recession during the second half of 2023. So yes, there could be a tailwind from global liquidity around that time. But that is also the time we would expect China to have opened up and domestic deposit rates in India to have gone up. From an EM perspective, we would still be cautious on India.

How are global investors’ India positioning? What is the outlook for FPI flows?

The FPI selling intensity in the first half of the year was the highest since the global financial crisis. While FPI flows have reversed somewhat, given the high valuations and our expectations of the rupee depreciating to Rs 85 per dollar by the end of 2022-23 (FY23), we do not expect high levels of FPI inflows.

Our earnings tracker shows India’s earnings momentum isn’t very different from the other EMs. In particular, with UBS expectations of a gradual reopening in China in the first half of 2023, flows could return to China.

What are your earnings estimates for FY23 and 2023-24 (FY24)? Which sectors will be the key contributors to growth?

While we are apprehensive about Indian equities, it entirely emanates from our concern on valuations rather than earnings. We are mostly in line with the Street earnings estimates for FY23 and FY24. Banks do well in rising rate cycles, and with a comfortable credit cost outlook, we expect banks to do well on earnings. We expect materials to drag earnings.

Do you have any Nifty targets for the next one year? Which are the sectors/themes you are bullish/bearish on?
 

We have our mid-2023 Nifty50 target at 15,500. Given our earnings expectations, we are mostly bullish on banks and bearish on materials.