The dominant driver of the market rally in India is the robust foreign portfolio flows into India starting from May this year. In January and February FPIs were sellers in India and buyers in China. Expectations around the opening of the Chinese economy post-COVID persuaded FPIs to invest in China massively. China was cheap and India was relatively expensive. Consequently, the FPI strategy was, ‘Sell India, Buy China.’ In January and February, FPIs sold stocks worth Rs 34,200 in India. This consistent selling and the negative sentiments dragged the market down.
The FPIs took a ‘U’ turn in their strategy starting in May. In May and June, FPIs bought heavily in India: Rs 43,838 crores in May and Rs 47,147 crores in June. The relentless buying continues in July with an investment of Rs 33,250 crores (including bulk deals) till 21st July. The FPI strategy has reversed from ‘Sell India, Buy China’ to ‘Buy India, Sell China.’ It is important to ask, ‘Why this U turn in FPI strategy?’
There are some serious trends in the Chinese economy which have significant implications from the market perspective. Growth in the $ 19 trillion Chinese economy is decelerating fast. There are some fundamental issues dragging Chinese growth down. The Chinese population has peaked and has started declining. An economy where population is declining cannot sustain long-term growth above 3 percent. This is the lesson from economic history. Apart from this demographic shift, the Chinese economy is suffering from serious problems in the real estate sector. The property market, accounting for 30 percent of GDP, has been the driver of growth in China for many years. Housing starts have declined by 21 percent this year and youth unemployment has shot up to an alarming 20 percent this year. China has been trying to move away from investment-led growth to consumption-led growth; but the strategy has not succeeded, so far. Consumption remains stuck at 40 percent of GDP. Chinese debt to GDP, which is at an alarming 287 percent, leaves little room for fiscal stimulus. In brief, growth in China is likely to remain anemic for many years. Apart from this, the anti-business policy being followed by the Xi Jinping regime and the harsh regulatory controls have queered the pitch for the Chinese stock market. Shanghai composite Index is now at 3200, lower than the June 2008 level. Even at a PE of 9, FPIs are avoiding the Chinese stock market.
India, in sharp contrast, is doing well. The economy is in a sweet spot with impressive growth with macro stability. Indian stock market is a consistent performer. The return from Indian stock market in dollar terms has been the best in the world if we take the last 20-year period. There is a near global consensus that India will be the fastest growing large economy in the world for many years to come. An $8 trillion Indian economy with a market cap around $10 trillion by 2032 is achievable for India. The stars are aligned in India’s favor. This is the fundamental reason behind the FPI surge in India. Of course, there will be short-term challenges which will impact these flows.
While the long-term prospects of India look excellent, the concern is the market valuation. India is now one of the most expensive markets in the world. At 19,900 Nifty is trading above 20 times FY24 estimated earnings, which is significantly higher than the long-term average of 16. The problem with high valuation is that the correction, when it comes, can be swift and sharp. So, even while riding the bull, investors should remain cautious.