Nomura retains ‘neutral’ stance on Indian equities for 2022; here’s why

“High earnings growth expectations do not leave much room for disappointment; slowing retail trading participation takes one support away from the market; sticky core inflation raises the risk of higher policy rates (our team pencils in 100bp of policy rate hikes in 2022 starting April),” the firm said in its report.

Nomura, which is ‘neutral’ on its Asia Allocation for India said that among the key aspects in favour of the domestic stocks was a high earnings growth market, the size and liquidity (acting as a counterweight to North Asia) and the fact that the country is home to a number of high quality and high growth stocks.

A relatively lower degree of exposure to global trade also works in favour of Indian equities, the firm said, pointing out that from a long-term investment perspective, the prospect of rising Foreign Direct Investment (FDI) on account of the domestic manufacturing push provided by the Product Linked Incentive scheme would work favourably for the country’s stock markets.

The low share of equities in household financial assets and consequently sustained retail support would also bode well for Indian shares, while a growing unicorn universe suggests a good pipeline for equity markets, Nomura wrote.

On the other hand, the key risks or negatives flagged by the foreign firm include the future course of COVID-19 pandemic, especially as India is lagging the region when it comes to rollouts of vaccinations, Nomura said.

“Stretched government finances raises the risk of populism/higher taxes especially ahead of some state elections,” was also cited as a red flag by the firm.

Nomura also highlighted India’s vulnerability to hardening US bond yields and a tighter monetary policy by the Federal Reserve, given the stretched domestic equity valuations.

A certain degree of reversal of reforms, especially after the recent repealing of farm laws, could also pose hurdles to India’s equity story in 2022, the firm said.

Nomura’s India Economics Team does not see the prevailing growth cycle in the country as being a durable one and expects the business cycle to peak in the second half of calendar 2022, without a durable capex (capital expenditure) ‘upcycle’.

“Overall, we do not see the current growth cycle as durable. With mixed growth, high inflation and wider twin deficits, we expect India’s risk premium to rise, and the RBI to catch up as it falls behind the curve,” economists from Nomura’s Global Markets Research team wrote in their Asia Macro Outlook for 2022.

Citing inflation in India as a repeat offender, Nomura’s economists wrote that sticky consumer prices were a key macro concern for the country.

The positive impact of a recent cut in excise duties on petrol and diesel notwithstanding, other headwinds on the demand and supply side may build up, the report added.

On Wednesday, the RBI left interest rates unchanged, citing the necessity for extended policy support to ensure a sustained recovery in the COVID-ravaged Indian economy. Some analysts had expected a hike in the reverse repo rate amid the build-up of inflationary pressures in the country.

According to Deputy Governor Michael Patra, economic growth was still really weak and the output gap in the country would take years to close.

Nomura’s economists, however, believe that the output gap is likely to shift to the positive territory in 2022 – a phenomenon that traditionally corresponds to higher core inflation.

“Inflation expectations have shifted higher to around 11 per cent, consistent with underlying inflation of ~5 per cent and, if expectations exceed 12 per cent levels, the historical relationship suggests inflation could trend significantly above 6 per cent (the RBI’s upper tolerance threshold).”

On the macro front, Nomura also said India’s ‘twin deficits’ – the Current Account Deficit and the fiscal deficit – were on the wrong track, with the basic balance of payments back in the red and fiscal consolidation likely to be put on the backburner.