India's inflation is accelerating even faster than expected and inflation expectations are increasing sharply. Loose monetary policy cannot last and the adjustment is likely to be uncomfortable for equities.
India equities (BSE 500 index) are down 11% ytd in total US$ terms, almost 10pp better than China, but 20pp worse than Brazil. Indian equities have recently de-rated but so have EM peers in the global sell-off and India remains more expensively valued versus history than these peers.
Loose policy meets inflation spike
India's April yoy inflation came at 7.8% (data released on 13 May) versus the 7.4% consensus expectation (Bloomberg) and the prior month's 7.0%. The central bank's target range for inflation is 2% to 6%.
The implied real interest rate is negative 3.4%. An extended period of negative real interest rates supports growth and pushes investors, in particular, into equities as long as inflation expectations remain contained and central bank credibility remains intact.
However, consensus 2023 inflation expectations are increasing sharply, now 6% compared with 5% at the start of March 2022.
Loose monetary policy will likely have to be reined in and this may make for a difficult adjustment period for equities, irrespective of the global backdrop.
And there is little room for fiscal policy to counter this given the deficit as a percentage of GDP for this year is heading towards 10%, according to IMF forecasts.
Fading policy stimulus adds to other concerns on Indian equities.
Structural reform is seemingly off the table until at least the 2024 election, and civic unrest risk, resulting from illiberal politics, has not abated.
Indian equities are more expensively valued versus history than those of other large EMs, eg China.
Foreign flows have turned significantly negative (and local investor bases tend to be very sensitive to policy rate hikes).
Our EM Country Index in this context
In our EM Country Index we incorporate short and long-term macroeconomic growth factors but also measures of policy credibility, eg real interest rates to reflect whether policy-makers are ahead or behind the inflation curve.
Our index weights c30 factors on growth (short and long term), policy credibility, politics, sanctions, ESG, equity valuation and liquidity. The weights in the index can be changed in order to model different global themes and portfolio styles.
Among large EM peers, in our index, India ranks behind China, Taiwan and Saudi Arabia, similarly to South Korea, and ahead of Brazil and South Africa.
India's stimulus may not be sustainable, Feb 2022