India is likely to be the world's fastest-growing large economy in the next ten years and hit $6 trillion which would propel its equity markets to a fresh record high, says a report.
According to global brokerage Morgan Stanley, the concomitant impact of higher GDP growth is that corporate earnings growth is also likely to accelerate which should propel equity markets.
"We estimate that digitisation will provide a boost of 50-75 basis points to GDP growth and forecast that India will grow to a USD 6 trillion economy and achieve upper-middle income status by 2026-27," Morgan Stanley head India research and India equity strategist Ridham Desai said.
India's history shows a good correlation between nominal GDP growth and earnings. Ultimately, earnings growth is what drives share prices – but we also expect Indian multiples to expand.
Morgan Stanley expects India's stock market could be among the world's best performers in the next ten years, leading to India's market cap rising from ~US$2 trillion to ~US$6 trillion.
The global investment bank sees the BSE Sensex crossing the 100,000 mark in the base case scenario and 1,30,000 mark in the bull case scenario, albeit the bulk of the returns are likely to be front-ended in the coming five years.
India could continue to be a strong equity market over the next ten years with a potential 24% CAGR in US dollar returns over the coming five years.
Morgan Stanley expects such a return to be driven by acceleration in earnings growth (12% CAGR, 2017-27, in US dollar terms), as well as by multiple expansion.
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The starting point of under-penetration combined with digitization almost guarantees growth in financial assets and liabilities on the household balance sheet, driving up the size of the domestic mutual fund industry and household ownership of equities, it said.
“We would focus on investing in the financials, consumer, and emerging large caps categories, while avoiding global sectors, such as technology and pharmaceuticals, to play this story,” said the Morgan Stanley note.
Together the financials and consumer sectors could account for 63 percent of India's market by 2027, up from 47 percent currently, largely at the expense of global sectors such as software services, pharmaceuticals, materials, and energy.
“We forecast market capitalization of the financial sector to grow 4x from current levels to US$1.8 trillion in the next ten years: The past two decades have been very strong for Indian financials,” said the note.
The listed market cap has increased from less than 2 percent of GDP in 1998 to 16 percent now – an over 80x increase in nominal terms. This has been driven by various factors with the setting up of efficient businesses (private banks and well-run non-banking finance companies) as a key anchor.
Morgan Stanley looks for companies with a strong track record of return on capital as well as our estimated return on capital combined with reasonable stock valuations.