Indian equity markets gain significant heft in emerging market basket

Country's recent outperformance to China, higher foreign ownership limits boost standing

The Indian equity markets have significantly increased in importance within the emerging market (EM) basket of stocks in recent years. Since 2018, India’s weighting in the Morgan Stanley Capital International (MSCI) EM Index — tracked by passive funds with assets of nearly $500 billion — has doubled, while the number of domestic stocks has grown by almost 70 per cent.

Following the latest rebalancing by MSCI — which will come into effect at the end of this month — India’s weighting in the EM index will reach an all-time high of 16.3 per cent, and the number of stocks will rise to 131.

In 2018, India’s weighting was 8.2 per cent, with the number of stocks in the index being 78, according to data provided by IIFL Alternative Research.

“The increase in weighting over the years is owing to several factors. On the quantitative front, a growing number of Indian companies with large free-float market capitalisation have been added to the index. In qualitative terms, India offers far better diversification across industries compared to, say, Taiwan, where there is a high concentration in just the semiconductor sector. Also, China’s underperformance and India’s consistent growth and favourable demographics have helped it gain more clout in the index,” said Sriram Velayudhan, senior vice-president-alternative research, IIFL Institutional Equities.

The higher representation in the widely tracked global index will help channel higher foreign flows into a large number of domestic stocks.

Abhilash Pagaria, head, Nuvama Alternative & Quantitative Research, said the doubling of India’s weighting is a “remarkable achievement” and is underpinned by factors such as the move to increase foreign ownership limits in 2020, sharp rallies in the broader markets, and the relatively underperformance of other markets, mainly China.

“With a consistent flow from domestic as well as foreign participants, there is potential for India to surpass a 20 per cent share in the MSCI EM Index by 2024,” said Pagaria.

Broadly, foreign portfolio flows entering the country can be classified into two: passive (exchange-traded fund, or ETF, driven) and passive (non-ETF). The former has been gaining more prominence over the years amid the growing trend of investing through index funds.

For instance, listed global funds poured $1.3 billion into India’s equity markets in September, helping minimise overall outflows for the month to $500 million.

India’s weighting in the MSCI EM Index is second-most after China, with the gap between the two narrowing over the past few years.

A note by Axis Mutual Fund (MF) shows India’s weight in the MSCI EM Index has moved from 6.4 per cent in 2013, while that of China’s was 42.5 per cent. China’s weighting has now gone to 29.55 per cent.

“India has had a low representation in regional benchmark indices for years. But this has been slowly changing, and India has come a long way aided by the growth of Indian companies,” said the note by Axis MF.