India Inc's earnings depend on global growth; DII flows at risk: Nuvama

There is a risk to sustenance of DII flows itself as they lag-rather than lead-market movements. Weak one-year trailing returns could be a meaningful deterrent for domestic investors, the report said.

An overall improvement in India Inc's earnings report card depends on how events at the global level shape up amid tepid domestic demand, suggests a recent note by Nuvama Institutional Equities authored by Prateek Parekh.

 

Profit margins for corporate India are currently 'very elevated', Parekh said, with limited room for expansion. Drilling down, while top-line growth has been stuck in single digits for more than two years now, he believes, there has been a change in internals. 

 

In fiscal 2023-24 (FY24), top-line slowdown was essentially owing to external weakness, Nuvama said, while the domestic cyclical part of the economy—Autos, Real Estate, Credit, and Industrials—was buoyant. However, in FY25 weakness in domestic growth led the slowdown while exports stabilised at low levels. 

 

While the Reserve Bank of India (RBI) has cut the benchmark rate by 100 basis points (bp) on aggregate, Nuvama believes that they are shallow to revive domestic demand. In fact, transmission of rate cuts to bond markets has not happened and real rates are still quite elevated.  

 

 

Government’s GST reforms and income tax cuts are welcome and could spur some pockets of consumption, but they are likely to happen in the backdrop of fiscal consolidation. This, Nuvama believes, shall result in only limited aggregate demand multipliers given household incomes are weak and corporates are pruning capex. 

 

"Nearly two–thirds of BSE 500’s top-line growth is directly or indirectly influenced by global growth through trade and prices. It is no coincidence that India’s top line and exports growth have a very strong correlation. In the past, all recovery cycles have been export-led. The domestic factors-led decoupling of India’s earnings seems largely behind. India’s earnings prospects now will depend on global growth," Parekh wrote.

 

Valuations and flows

 

Emerging market (EM) valuations, Nuvama said, are now one-standard deviation (1-SD) expensive. With tariff revisions behind, Nuvama said the US dollar is now stabilizing and the Fed’s actions shall determine EM flows going ahead. 

 

Even on the flows front, the foreign institutional investors (FIIs), Nuvama said, are setting the marginal price. This is essentially because the strong domestic institutional investor (DII) flows are being offset with large supply from promoters as well as corporates.  

 

"There is a risk to sustenance of DII flows itself as they lag—rather than lead—market movements. Weak one-year trailing returns could be a meaningful deterrent for domestic investors,” Nuvama cautions. 

 

 

Meanwhile, during past episodes of narrowing US CAD (current account deficit), the markets, according to the report, corrected during initial rate cuts and bottomed only after equity correction cheapened valuations; and US 10-year yield fell 150–200bp. 

 

"Today, valuations are still high and while the Fed has hinted at easing, yields remain quite elevated (despite 2024’s 100bp cut). Perhaps, a quantitative easing (QE) is needed to lower rates given the large UST (US treasury) supply. That said, during the past downturns, the Fed did not face the inflation dilemma. Any delay by the Fed could weigh on EMs’ (including India) capital flows," Parekh wrote.

 

With earnings at an inflection point, Nuvama maintains a defensive bias as a portfolio strategy and prefers large-caps over small-and mid-caps (SMIDs). Their key overweight sectors include Consumer, Telecom, Internet, Cement, IT, Pharma, Chemicals, while BFSI, Industrials, Power, Autos are among their key underweight sectors.