Might a surprise rate move derail India’s equity rally?

Please note: This article is written by our Investments team in India, and may reflect a different positioning versus portfolios managed in other regions.

All data referenced in this article is sourced from Refinitiv Datastream unless otherwise stated, and is accurate at the time of publishing.

Key points

• India’s inflation outlook remains key to any interest rate cuts. While domestic price increases are easing, stubbornly pacy food price hikes are a worry. The timings of any rate cuts, potentially in the final quarter, could also hinge on US policy 
• Local companies are forecast to deliver strong results this earnings season, but there is the potential for a market correction if they fall short of expectations. That said, the longer-term picture remains positive
• While Indian bond yields have fallen recently due to revised rate cut expectations, some bonds may still offer value – particularly the AA- and A-rated segments (3-5 years) 
• At times of high valuations for many listed Indian companies, and with geopolitical tensions rising, investors might consider diversifying their portfolios. Gold, traditionally seen as a safe haven, could play a role in managing risk. Additionally, India's rapid economic growth makes private assets potentially attractive for further diversification

The commencing of Indian general elections might be the big news domestically, but more signs that the US central bank would keep interest rates higher for longer was the main news for financial markets in April. While there seems little risk of more rate hikes in the short term, despite a motoring US economy, inflation remains some way off target. 

At home, India’s CPI inflation dipped to 4.85% year-on-year in March, from 5.09% in February. However, the strong pace of rises in consumer food prices, which account for nearly half of the overall consumer price inflation basket, remains a concern. The consumer food price index was little changed in March at 8.52%. By contrast, increases in Indian wholesale prices picked up to 0.53% month on month, from the 0.2% seen in February.

Industrial production data highlighted the strength of India’s economy, with February’s 5.7% year-on-year expansion the best seen in four months. That said, the trade deficit widened to $18.71 billion in February, from $17.50 billion in January, as imports outstripped exports in value terms. 

Keep an eye on geopolitics, earnings and domestic elections

Indian equity markets might seem to be little changed this year. However, it is a particularly volatile period to be investing in. Geopolitical fireworks in the Middle East or Ukraine and changed perceptions of where US interest rates are heading next are among factors influencing market volatility. That said, there was little response from the oil price to Israel’s missile strike on Iran last month. However, this needs to be closely monitored, with oil prices usually being particularly sensitive to events in the region.

The domestic annual earnings season got underway in April, with many expecting companies to chalk up healthy earnings growth. As such, the outlook for Indian equity markets remains encouraging. Investors are discounting a third term for the incumbent, business-friendly government, with the results of the latest election due on 4 June. 

Given all the uncertainties, both domestically and elsewhere, this appears to be a good time to remain focused on quality companies that are expected to deliver strong earnings and are available at reasonable valuations. That said, sharp price falls in the short term are not out of the question, should the earnings season disappoint, or if there is a shock election result, to name but two risks.  

We continue to prefer domestic cyclical growth themes, particularly opportunities in sectors like power, manufacturing, infrastructure, capital goods and select consumer discretionary segments. 

Bond investors focused on central banks’ rate stance

Inflation, particularly in the US, has been more stubborn for longer than many expected at the start of the year. Consequently, market expectations on the timing of a return to target were pushed back in April. 

US rate expectations matter for Indian policymakers as well, with the outlook for consumer prices being a major variable for the Reserve Bank of India’s (RBI) rate decisions. The central bank’s next meeting of its Monetary Policy Committee (MPC) is scheduled for 7 June 2024, and key factors likely to influence policy could be:

• The latest consumer price index data, which will be for April 2024. 
• The European Central Bank policy meeting scheduled for 6 June – where a potential rate cut is on the agenda. 
• May’s US Federal Reserve policy decision, the June meeting falling after the ECB’s one. However, expectations are for policymakers to keep rates on hold at that point.  
• Number and severity of monsoons, the season projected to be better than normal.

Taking all of the above into account, the odds are for the RBI MPC to keep rates unmoved in June. Indeed, any rate cuts may only be seen in the final three months of the year. 

The recent reversal in 10-year bond yields offers more value for those investors who are willing to invest over at least a 24-month horizon. That said, those staying invested over this period might find it a rough ride, with volatility levels being key for duration call. With spreads still appearing attractive, the 3-5 year AA- and A- rated segment of the debt market remains attractive from an accrual perspective. 

Diversification through gold and private markets

At times of high valuations for many listed Indian companies, some worrying geopolitical tensions in the Middle East and the increasing risk that interest rates will be kept higher for longer, gold and private markets might warrant a role in further diversifying portfolios. The former is a star performer this year, usually being a ‘safe-haven’ bolt hole for investors when geopolitical tensions soar, while the latter could prosper from Indian economic growth rates that lead other leading economies¹.