Asset classes – Indian multi-asset portfolio allocation

Can India lead the growth pack this year?

06 March 2023

Narayan Shroff, India, Director-Investments

Key points

  • As several leading economies skirt with recession, India may be on track to be the world’s fastest-growing economy in 2023
  • However, allegations of corporate fraud have rocked Indian equity markets so far this year 
  • Yet, despite the recent volatility, there are reasons to be optimistic – a business-friendly government, lower-trending inflation and upbeat earnings all potentially point to a brighter future 
  • There was also a surprise uptick in inflation in January, yet bond investors can take solace from the longer-term picture, as the point of peak interest rates seemingly nears

Despite concerns around one of the country’s largest conglomerates and a surprise uptick in inflation having already hit India’s financial markets this year, the long-term signals for domestic equities remain promising. The country is on track to be one of the quickest, if not fastest, growing top-20 economies this year, backed by a government keen to support business.

The outlook for the global economy seems to be improving, with expansion being driven by emerging markets this year. Global growth is forecast to hit 2.9% in 2023 (up 20 basis points (bp) from expectations in October), according to the International Monetary Fund (IMF), with emerging market economies predicted to grow by 4% (up 30bp)1. The reopening of China’s economy after the removal of its zero-COVID policy last year is largely responsible for the more optimistic growth figures.  

The outlook for inflation also appears to be improving. The IMF predicts that inflation of 8.8% last year will soften to 6.6% in 2023 and 4.3% in 2024. 

As the global outlook picks up, India looks like remaining one of the strongest expanding economies, among the 20 largest ones, this year, according to Barclays Investment Bank. Turning to the prospects for inflation, the Indian central bank predicts that price growth will moderate to 5.3% in fiscal year (FY) 2024 from 6.5% in FY 20232. That said, the potential demand boost from a revived Chinese economy, and potential boost to commodity prices, might nudge inflation higher.  

Indian equities keep shining, despite recent squalls

Equity markets were boosted by February’s Union budget, fears of an increase in capital gains tax proving to be misfounded.  

That said, Indian equity investors were shaken by a report on a major Indian conglomerate. Shares related to that group and to those potentially exposed to it, especially in financial services, were sold off. As the short-term mood soured, foreign institutional investors sold more than 340 billion rupees-worth of domestic equities than they bought in the first two months of 2023, according to India’s National Securities Depository Limited.

Earnings prospects look promising

Despite the short-term net selling of Indian equities, the outlook for earnings at Indian companies is encouraging. While growth in sales volumes was muted, fourth-quarter 2022 earnings were better than expected for many domestic groups, with margins improving across most industries. 

Financials and autos stocks drove earnings growth, although commodity-related sectors such as energy, metals and mining acted as a drag. At financial companies, results were buoyed by healthier borrowing and improving net interest margins. While earnings at technology groups were generally better than expected, the outlook seems murkier, as a series of job cuts hits the sector and signs are seen that clients may be postponing purchasing decisions. 

More domestically-focused companies appear to offer better prospects than those with more international exposure. India’s vibrant economic prospects are likely to encourage stronger volume growth, while any normalisation in margins should drive an expansion in earnings growth for local businesses. 

At the sector level, defence and infrastructure groups, along with those selling capital goods, look well placed to benefit from more capital expenditure.  

As the short-term surge in volatility in the equity market eases, investors are likely to focus more on the encouraging earnings outlook and macro data (both domestically and in other leading economies).

Inflation shock shakes bond investors

January’s shock increase in the Indian consumer price index (CPI) to 6.5%, up from 5.7% in December, was driven by a significant uptick in food costs in the month, that supports the Reserve Bank of India’s continued hawkish stance. While February’s inflation data might continue to be above the central bank’s 6% upper target limit, the longer-term trend is still lower. 

If inflation keeps being stronger than expected, this will increase the risk of another rate hike in April. That said, as core inflation remains more subdued, the latest inflation scare is unlikely to affect the terminal rate. 

Despite the long-term downward trend in inflation, bond investors are likely to remain gripped by the volatile geopolitical outlook and persisting recession risks, even if more subdued in recent months, in many leading economies. Should volatility increase, the RBI is ready to provide timely and appropriate support to bond markets, in terms of boosting liquidity and policy flexibility, as and when is deemed appropriate.

But long-term bond prospects remain encouraging

Medium- and long-term bonds seem preferable at the moment, as does a blend of 3- to 7-year corporate bonds and sovereign debt. 

Locking in yields close to policy rate peaks has generally proved to be an assiduous strategy. Given the flattish yield curve, it might be a good time to lock in yields. 

Asset allocation and diversification key to navigate volatility 

After a tough year for investors, 2023 is likely to be another volatile one given the propensity for inflation, growth and central bank policy surprises to rock financial markets. That said, while it may be a struggle, investors should stick to their long-term asset allocation strategy and use any sell-offs as opportunities to rebalance portfolios. 

As many equity markets test new highs, the rally seen in risk assets since October may be on its last legs. A continuation in the rally will be more difficult, until more clarity emerges on growth, inflation and the peak in interest rates. 

With the surge in COVID-19 deaths in China seen since the removal of the zero-COVID policy last year seemingly having peaked, economic growth in the country is on track to bounce this year.  

In turn, Chinese equities are performing well against other major equity markets. Domestic policymakers are ready to do more to support the economy and the property market. That said, weaker home sales, slowing exports and restrictions on the imports of US semiconductors remain among the potential risks to growth.

Alternative assets

Given the volatility seen in Indian equity markets and financial markets more generally this year, private markets continue to offer opportunities to diversify portfolios across both private equity and private credit.

With persisting levels of high inflation, investing in real estate investment trusts (REITs) and infrastructure investment trusts (INVITs) could provide a hedge against even higher inflation.  

Both asset classes tend to perform relatively well in inflationary periods. Indeed, the recent sell-off in REITs and INVITs should also be a tailwind for the asset classes. However, with recent taxation changes, investments in such areas should be considered as long-term in nature.

With another particularly volatile year expected, gold may, as usual, provide a “safe-haven” for investors when volatility spikes. Additionally, the yellow metal can also act as an inflation hedge while helping to diversify portfolios. In the current environment, any escalation in geopolitical risks, recession or weaker earnings is likely to dampen investor sentiment and, in turn, be a positive for the yellow metal.

Related articles