The strong movements in the equity markets ? especially when the reforms are yet to take off, and when the monsoon is deficient ? are being doubted and there are calls of a correction. While the market may correct in the short-term and take a pause, there are indications that the long-term journey would remain solid.
From a pure statistical perspective that analysts use, the returns would be attractive. Analysts at Morgan Stanley Research estimate the risk premium, the extra returns that investors should expect while risking investments in equity markets, will be 6%. “Using the current local risk-free rate of 7%, investors will likely earn an annual compounded annual return of 13% from their investments in the BSE Sensex over the coming decade,” add analysts at Morgan Stanley Research.
According to them, the short-term call remains a difficult one. However, the market is pricing in the growth recovery we are forecasting in the coming six months. However, with a 12-month view, the market offers upside since we expect that growth will continue to accelerate in 2011, they add.
Number crunching apart, there are some fundamental tectonic shifts that have steadily shaped the landscape over the years. And these will remain to support the markets. Analysts at CLSA Asia-Pacific Markets reckon that Indians are investing more of their savings in equities (directly or through equity products offered by institutions), and these have made domestic institutional investors (DIIs) a strong force. This can be seen from the fact that over the past five years, DIIs invested around Rs 22,000 crore, or $50 billion, in equity market and this is nearly 30% more than foreign institutional investors (FIIs).
They also state, “We expect favourable demographics, rising incomes and socio-economic changes to drive the equity savings rate higher, as was seen in the US in the 1980s and 1990s.” Over the next 10 years, they forecast that the Indians would invest $600 billion in the equity market. This is a staggering number considering that it is nearly 65% of the current market cap and more than 1.5 times the current equity free float.
The estimate is based on the reasoning that the Indian households’ financial assets totalled Rs 61.6 lakh crore ($1.2trillion) as of June 2009. Of this, 63% was in the form of cash and deposits; equity-related investments formed a small 10% and every percentage shift in total deposits to equities would lead to an inflow of Rs 35,000 crore. In other words, a shift of 10% would mean an inflow into equity markets of $70 billion. This would be more than the cumulative inflows from either DIIs or FIIs in the past six years and equal to 18% of India’s current listed free-float market cap, they add.
Also, overseas investors would continue to throng the Indian market given these dynamics. They have pumped $ 62 billion into Indian equity markets since the financial year 1993 and the current value of their total holding is $147billion. As of August 2009, there were 1,685 FIIs registered with the Securities and Exchange Board of India (Sebi) and this number has doubled over the past three years.
Currently, the FII trading volume is approximately twice that of the DII volume, indicating that they largely control trading movements in the long-run. However, the lesson from the market meltdown in the whole of financial year 2009, when FIIs pulled out around $16 billion from both the major exchanges, has a positive side to it. At this time, DIIs stepped in and saw that panic was not created. They invested around 82% of the FII outflow $13 billion, providing support for the next rally to emerge. As the equity cult spreads and more participation comes in, chances of reduced volatility get stronger.
“The fact that India has a strong regulator and processes ensuring fairness and transparency also add to the lure of being in this market place. Sebi has been proactive and there is a lot of faith in the system,” says a senior executive with an FII fund. He points out to the fact the markets came out unscathed during the huge selling pressure, a redemption crisis for mutual funds and the Satyam Computer scam, speaks volumes of the integrity.
That apart, the breadth and width of the Indian equity market have improved over the years. The CLSA report points out, “Average daily turnover (cash equities) has quintupled from $750 million in 2002 to $3.6 billion over the past 12 months. The daily turnover of equity derivatives (futures and options) has shown an even more phenomenal jump, rising by 35 times from a meagre $300 million in past year.”
Also, the number of large-cap stocks has grown. Additionally, newer sectors are added. Large listings like DLF, Suzlon, PowerGrid, Cairn, NTPC and Bharti, have made it attractive for investors. Now, they can truly participate in the India growth story and also diversify efficiently. And, as the economy grows there would be more stocks and sectors joining in. Ten years ago, investors did not have exposure to real estate, wind energy and telecom stocks. These listings and the widening of the market has seen India’s share in the World MSCI Index, which is followed by global investors to take portfolio decisions, has grown from 0.2% in 2002 to around 1% now.
Moreover, sitting on the sidelines are the pension funds. While the new pension scheme has not taken off for the moment, the sheer dynamics of numbers of funds being directed to the equities markets is staggering. Check this: currently, only 2% of Indian pension-fund assets are in equities, as compared to the 40% in developed markets and 20%-plus in emerging markets, indicate experts.
Of an estimated workforce of 3,210 lakh, only 12% is covered by pension schemes. Total pension fund assets, including the various options like provident funds, pension funds and the deposit-linked insurance scheme are less than 6% of the GDP as compared to compared to 50-100% for most developed economies.
However, the real concern is now about the pace of reforms and all eyes are trained on it. Especially, reforms in the financial sector with a focus on inclusive growth where distribution of financial products takes place efficiently and reaches all nooks of India. Already companies have started tapping this semi-urban and rural sector for the next level of growth. Any delay in implementation could hamper the pace of growth.
Now, there are concerns regarding the proposals in the direct tax code which would entail removing tax incentives on investments in insurance products and levy tax on returns from insurance products. However, global experience shows that when tax incentives are removed from the insurance sector, the asset management businesses flourish. “In which case, our key thesis on a larger participation in equity markets by domestic investors remains unchanged,” says the CLSA report.