India’s Ambitious Budget Can Power Stocks Another 10% Higher

(Bloomberg) -- India's plan to spend its way out of the coronavirus funk is capturing the imagination of stock watchers, with some rushing to revise higher their targets for the nation's equity benchmarks.

Morgan Stanley now sees an upside of almost 10% from current levels for the S&P BSE Sensex by the year-end, even as the gauge has climbed more than 7% in two sessions, disregarding concern over valuations in one of Asia's most expensive equity markets.

The budget may further boost the appeal of local stocks for global funds, who have bought shares so far this year while selling Indian debt. But the plan to spend almost $500 billion signals more pain for bond traders.

India's benchmark 10-year sovereign yield extended its advance Tuesday after climbing by the most since May on Monday following the budget, putting pressure on the central bank to step in. Yields on rupee corporate bonds also jumped across the curve a second day.

“Government spending coupled with reforms and greater privatization thrust could support economic recovery, create earning upgrades in FY22 and thus support India's premium valuations,” according to Rahul Singh, chief investment officer for equities at Tata Asset Management Ltd. India can see “superior earnings momentum especially if the budget is successful in reviving the investment cycle,” he said.

READ: Record Valuations Raise Alarm in Frenzied India Stock Market

The Sensex has already wiped out the 5.3% loss it suffered last week ahead of the budget event, and is now trading at 22.6 times earnings on a blended basis, versus a five-year average multiple of about 18.

Corporate Profits

Stock-market sentiment has also been buoyed by the absence of new taxes on the wealthy and corporations in the budget. Traders expect the government's growth push to boost corporate profits, which are already showing signs of a recovery. As the results season continues, most of the 29 NSE Nifty 50 firms that have reported earnings so far have beaten analyst estimates.

If the budget measures are executed properly, they have the potential to increase the share of corporate profits in gross domestic profit, and help bring about a new private investment cycle, recovery in domestic equity flows and earnings growth, analysts at Morgan Stanley wrote in a note.

READ: Citi Raises Nifty Year-End Target to 14,500 After India Budget

Strategists have also added to their bullish views on cyclical stocks. Financials are the top bets at Morgan Stanley, Citi and Jefferies Financial Group Inc., followed by sectors such as infrastructure and industrials.

“We do not believe high-quality Indian companies' valuations are fully factoring in this growth,” Nuno Fernandes and Tom Masi, fund managers of emerging equity strategy at GW&K Investment Management LLC., wrote in emailed comments. “Indian companies with long duration growth rates are likely to continue to warrant a premium valuation.”

Spotlight RBI

While massive global and local liquidity saw Indian stocks and sovereign bonds rally in 2020, the budget may trigger a divergence in performance between the two asset classes.

A lot, however, depends on the extent of the Reserve Bank of India's support measures. The RBI's open-market purchases have been key to keeping yields anchored despite the government's debt sales. Traders will seek assurance when Governor Shaktikanta Das announces the policy decision on Friday.

The RBI has its task cut out to ensure the borrowing program is smooth, Sonal Varma, chief economist, India and Asia, ex-Japan for Nomura Holdings Inc., wrote in a note.

Greater support from the central bank may be needed, said Avnish Jain, head of fixed income at Canara Robeco Asset Management. The change in the fiscal path may be negative from the country-rating perspective and adverse comments from rating companies may be bond negative, he said, adding that markets are likely to remain negative in the short term.

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With assistance from Bloomberg