Taking Post-Budget Stock

The impact of a Union Budget on stock valuations is limited. What markets look for is stable regulations and certitude of legislation. Indian stock valuations may be stretched but markets have a self-correcting mechanism. Bulls and bears, long and short sellers, create an equilibrium. When stock markets rise to record highs many worry that those valuations don’t reflect the real state of the economy. Jobs are scarce, inflation is up, the gulf between the top 20 per cent earners and the bottom 80 per cent has widened. Two key questions arise. First, are Indian stocks overvalued compared to their global peers? Second, what impact will the 2022-23 Union Budget have on stock valuations?

Consider the first question. According to Bloomberg, the S&P BSE Sensex has a price to earnings (P/E) ratio of 26. The Shanghai Composite index in China has a P/E of 15. The average P/E in the MSCI World index for global stock markets is 14. But the average P/E in the MSCI Emerging Markets index is nearly 22, within range of the BSE’s P/E of 26.

Stock valuations are forward looking. They take into account several factors, including principally economic growth. The latest International Monetary Fund (IMF) estimate has raised its projection of India’s GDP growth rate in 2022-23 from 8.5 per cent to nine per cent. According to the IMF, average world GDP growth in 2022-23 will be 4.4 per cent, half India’s growth rate. Based on these estimates, a P/E of 26 for Sensex stocks may be high but not irrationally so.

The second factor that influences stock valuations is corporate earnings. Indian firms have had a stellar October-December 2021 quarter. Profits may slow in the January-March 2022 quarter due to the lingering effect of the Omicron Covid-19 variant and the chip shortage that has hit automotive and electronics firms. But overall corporate profitability, especially of banks and IT services companies, will likely be strong.

The third factor is inflation. While the consumer price index (CPI) is still below six per cent, rising fuel and food prices have severely impacted the wholesale price index (WPI). It has been in double digits for several months. This has raised input costs across sectors. Some of the costs have been absorbed by firms but a significant portion has been passed on to the consumer, adding to inflationary pressure. Crude oil prices have spiked following the standoff between Russia and the West over Ukraine.

Turn now to factors that are positive for the Indian economy. One of the metrics economists tend to overlook is the difference between “nominal GDP growth” and “real GDP growth”. Nominal GDP is the metric used by the IMF and World Bank to rank countries.  Real GDP is measured at constant 2011-12 prices. Nominal GDP is measured at current prices and factors in inflation.

Hindustan Times’ data editor Roshan Kishore explains the difference: “GDP statistics are released at both current and constant prices. The latter discounts inflation from the base year of the current GDP series. While real GDP matters to track the growth of actual output, nominal GDP is important on at least two counts: government finances and terms of trade, or ratio of prices, between sectors. A look at quarterly GDP statistics shows that the nominal growth component, or the difference between current and constant price growth, has increased sharply in the current fiscal year that ends in March 2022.”

With the IMF estimating India’s real GDP growth in 2022-23 at nine per cent, nominal GDP growth, assuming six per cent CPI inflation, would be 15 per cent. If the rupee does not depreciate by the same inflation rate of six per cent, India’s nominal GDP could rise in the near future by over 10 per cent a year in dollar terms. That would be a major boost for stock valuations.

Stock market valuations are important for the government’s privatisation plans. The market valuation of 70 central public sector units (CPSUs) listed on stock exchanges is Rs 23 lakh crore. With the (unlisted) Air India sale to the Tata Group completed, attention has shifted to the initial public offer (IPO) of Life Insurance Corporation (LIC).

If the post-listing market capitalisation of LIC, even in a volatile market, is Rs 15 lakh crore as expected, the total market valuation of listed CPSUs will rise to nearly Rs 40 lakh crore. The government is divesting only 10 per cent of LIC’s equity in two tranches, including one before March 31, 2022. Its 90 per cent holding in listed LIC will alone, therefore, be valued at nearly Rs 14 lakh crore.

Following the 2022-23 Union Budget, if the government now doubles down on privatisation, lower personal income tax and implementation of labour legislation, the mood in the stock market can turn swiftly.

Foreign-based analysts, their views free of politics and prejudice, are especially bullish. As Ritu Arora, Chief Executive Officer and Chief Information Officer of Asia Allianz Investment Management, Singapore, recently told Business Standard: “The Nifty’s 10-year CAGR (compound annual growth rate) is 15.03 per cent and 20-year CAGR is 16.66 per cent. Since inception (22 April 1996) the CAGR is 12.75 per cent. An 8 per cent correction from the peak implies that the Indian markets are about 1 standard deviation more expensive than long-term averages. This needs to be seen in conjunction with the strong earnings growth cycle that has sustained.

“Investors who know India well regard it as a long-term structural growth story that would soon be the third-largest economy in the world. Our GDP will be adding trillions every few years, and the growth super-cycle is expected to last well beyond 2050. The domestic market is integrating ever so closely with the world. Most of all, we are starting from a low base and the best is yet to come. This makes India a uniquely attractive investment destination, much more attractive than any other emerging market (EM).”

Union Budgets come and go but the resilience of the Indian economy, which underwent a trial by fire during the Covid-19 pandemic, has emerged largely unscathed. The future, as Singapore-based Ritu Arora says, beckons.