India's equity mania meets psychological test as returns outlook dims

By Andy Mukherjee

 

Throughout this decade, India’s household savings have steadily left the safety of bank deposits to chase returns in equities. This migration was supposed to provide a stable pool of risk capital to entrepreneurs and act as a shock absorber against fickle hot-money inflows from overseas. 

The war in Iran has punched holes in this cheery thesis that a ceasefire may not mend.

 

For the first time since the pandemic, individual investors were net sellers in the secondary market in the first 11 months of the financial year that ended in March.

 

That sign of pessimism, which predates the war, could become more pronounced because of the dislocation that has already been caused by the conflict. Much of the 19 per cent annualised, three-year return on the Nifty Smallcap 100 Index came from bumper performance in 2023 and early 2024. That will soon vanish. If the benchmark stalls at current levels, the new three-year return in March 2027 will be just 1.3 per cent.

 

 

Unless valuations reset at more attractive levels, the psychological shock of low realized gains could pour cold water over expectations of future outperformance. At risk are the so-called systematic investment plans, through which the middle class has poured nearly 6 trillion rupees ($62 billion) into mutual funds since early 2024. These plans are the “big bang” phenomenon for the Indian capital market, Bernstein noted in a March 11 note. “We remain watchful of how retail investors behave if markets remain sideways for the next 12 months,” the analysts said. 

 

Should people stop wiring small sums of money every month to mutual funds, the intermediaries that depend on them could be in big trouble.

 

The fear of a reversal is weighing on the shares of capital-market intermediaries. Before Wednesday’s ceasefire-inspired surge, HDFC Asset Management Co.’s shares had fallen about 15 per cent over six months. Brokerage Motilal Oswal Financial Services Ltd. had tumbled 25 per cent.

 

Investment bankers, too, are on edge. From tycoon Mukesh Ambani’s digital empire to the National Stock Exchange, the leading bourse, large initial public offerings are in the works. Beyond those marquee names, however, there may not be much investor appetite. PhonePe, a fintech owned by Walmart Inc., has delayed its IPO. Expect others to follow suit.

 

Ambani’s Jio Platforms Ltd. listing is likely to consist entirely of an offer for sale by existing investors such as Meta Platforms Inc. and Alphabet Inc. The company won’t receive fresh funding. This reflects a trend. Last year, more than 60 per cent of the IPO fundraising in India ended up giving exits to firms’ original sponsors. The money didn’t create fresh assets. In fact, a lot of it may have left the country.

 

Overall, overseas investors have sold $22 billion of Indian equities over the past year. What will it take to bring them back? For one thing, New Delhi needs to rethink its capital-gains and securities transaction taxes — those are a buzzkill for global fund managers. Besides, valuations may still need to become a lot more reasonable.

 

On a price-to-earnings basis, the MSCI India Index is 70 per cent more expensive than the MSCI Emerging Markets Index. While this premium is lower than at its 2024 peak, global investors clearly expect India Inc. to cost even less.

 

That’s because of the elephant in the room: the rupee. Foreign investors usually factor in 5 per cent annual depreciation when evaluating dollar-denominated returns. Over the past year, the rupee has weakened 8 per cent. That’s a dampener, and not just for overseas investors. The more affluent Indian households — the bulwark of the market — also have substantial foreign-currency liabilities. Between maintaining second homes in Dubai and funding US college degrees for their children, their lifestyle is effectively dollarized. 

 

A lot is riding on the two-week ceasefire in the Middle East conflict. If the Strait of Hormuz reopens quickly and fully, India’s fiscal and current-account deficits may be elevated, but manageable. However, prolonged energy shortages could upend those calculations, and the Reserve Bank of India, which left interest rates unchanged Wednesday, may have to raise them to prevent an unruly collapse of the currency.

 

For a bank-led economy, large-scale migration of household savings into capital markets was always a risky strategy. 

 

The number of participants in the National Stock Exchange’s secondary market quintupled in five years through February 2025. From fund managers and distributors to exchanges and brokers, an entire industry benefited.

 

For a time, this “financialisation” of deposits sustained optimism by producing a wealth effect. Banks enabled their own hollowing out by lending ever-larger sums for share purchases. However, a lot of that money fed a speculative frenzy in low-quality, small-cap stocks.

 

The costs are mounting: Lenders are strapped for liquidity, which means borrowers aren’t getting the full benefit of the RBI’s cumulative 125 basis points of rate cuts since early last year. Meanwhile, savers can no longer find attractive yields in equities. The rank of new retail entrants thinned by 24.5 per cent in February. Throw in the shock of seeing three-year returns dwindle to nothing, and both investors and intermediaries may have a tough slog ahead.

 

(Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper)