Morgan Stanley Upgrades India To 'Overweight', Downgrades China

Morgan Stanley has upgraded India to 'overweight', citing a secular trend towards sustained superior dollar EPS growth versus emerging markets over the cycle, with a young demographic profile supporting equity inflows.

"India rises from 6 to 1 in our process, with relative valuations less extreme than in October, and India's ability to leverage multipolar world dynamics is a significant advantage," Morgan Stanley said in an Aug. 2 note.

Macro indicators remain resilient, and the economy is on track to achieve our 6.2% GDP forecast, according to our India Economics Team, the brokerage note said.

The research firm noted that, Indian economy is benefitting from a surge in inward foreign direct investment, including from U.S., Taiwan and Japan firms looking to its own large domestic market as well as a much-improved export infrastructure situation vis-à-vis more-efficient ports, road and electricity supply.

"Private equity firms are expanding in India (and ASEAN) at the same time as they are struggling with exits in China," the note said.

India Versus China

"India's future looks to a significant extent like China's past," the note said.

Morgan Stanley believes the GDP growth trend in China is likely to be 3.9% to the end of the decade vs. 6.5% for India. It also added that, for India a long period of stability in the real exchange rate seems to set to end with a break to the upside.

India is seeing favourable demographic trend, while China has seen decline in working-age population since the early part of the last decade, the note added

Morgan Stanley downgrade MSCI China to 'equal-weight', as concerns over growth and valuation remain. "The market moves down to 13 in our framework, given still-negative earnings revisions and weak ROE and profit margins vs. history, which undercut cheap valuations," the note said.

A Structural Story Unfolding, Says Ridham Desai

"India has experienced many changes in less than a decade. These include supply-side policy reforms such as a build up in infrastructure, formalisation of the economy via GST and IndiaStack, change in real estate regulations, digitalisation of social transfers making them leak proof, a new bankruptcy law coupled with a sharp decline in corporate balance sheet leverage, flexible inflation targeting, focus on FDI, India's 401(k) moment, which has created a reliable domestic source of risk capital, permission for retirement funds to invest in equities, government support for corporate profits and multiyear highs on MNC sentiment," Ridham Desai, managing director at Morgan Stanley India, said.

According to Desai, there are three anchors to India's likely multiyear bull market:

Macro Stability And A Secular Positive BoP In The Offing:

The boom in services exports following a shift in thinking about work from home by MNC CEOs, the declining intensity of oil to GDP, and a shift in funding of the current account to more stable FDI flows, the stock market's correlation with oil, the U.S. Fed's fund rate, and U.S. growth cycles has greatly diminished, removing the biggest macro challenge to investing in Indian equities.

Strong Relative And Absolute Growth

Helping profits are government incentives for the corporate sector via lower tax rates (set in 2019) and production-linked incentives to promote investments in targeted sectors. Another factor helping growth is the likely transition in India's income pyramid, which is likely to invert in the coming decade, leading to a few hundred million people exiting poverty, more than 100 million additions to middle-income households, and 20 million additions to rich households.

India's 401(k) Moment Has Created A Reliable Domestic Source Of Risk Capital:

Domestic households have supplemented this with systematic investment plans, an outcome of low equity exposure on household balance sheets, constant education by the mutual fund industry participants on the merits of systematic investing, and major regulatory reforms that have made the markets less prone to fraud and improved equity returns.

This is a big change for Indian equity markets compared to history, when the market relied largely on foreign participants for the bid

Key Downside

The key downside risks include an upside surprise in inflation and monetary policies, especially if productivity improvement does not catch up.

Another concern is more structural, as artificial intelligence may be disruptive for India's service exports and the labour force generally, although we will monitor the impact closely.