- September 16, 2022
India on the cusp of a capex boom: Morgan Stanley
Morgan Stanley anticipates India’s robust earnings cycle, driven by a new capex phase, bolstering industrial and financial stocks.
India’s coming capital expenditure cycle implies that the
country is in the midst of a strong earnings cycle with positive implications
for industrial and financial stocks, global investment bank Morgan Stanley has
The confidence stems from an improving trend in corporate and
financial sector balance sheets, along with a strong reform push by the
“We believe that India will see a new capex cycle changing the
growth dynamics and fostering a virtuous cycle of productive growth and we see
both the supply side and demand side factors favouring the onset of a new capex
cycle,” the report said.
A number of factors are seen in play for the revival of
private sector capex. These include cyclical improvement in demand and capacity
utilisation, cleaner corporate and financial sector balance sheets, structural
reforms such as corporate tax rate reduction, implementation of
Production-Linked Incentive (PLI) schemes and focus on infrastructure and
The corporate sector continues to deleverage its balance
sheets with “the corporate debt to GDP ratio expected at 47 percent in FY23 from
a peak of 62 percent in FY15”, Morgan Stanley added.
It expects the corporate debt growth to surpass nominal GDP
growth in FY24 after staying below it in the past nine years.
The banking sector’s balance sheet position between FY10 to
FY18 was constrained as impaired loans continued to increase, peaking at 12.4
percent of bank assets in FY18.
“Impaired loans have now decelerated to a 10-year low of 7.5
percent in FY22, indicating an improving balance sheet position to fund the
capex cycle,” said Morgan Stanley.
It is also seeing an inflection in credit growth with better
domestic demand. Year-to-date credit is growing at one of the highest rates in
10 years. Year-on-year (YoY) credit growth was 15.3 percent as of August 22,
partly because of a low base.
However, “we note that trailing three-year credit growth has
accelerated to 8.7 percent as against 6.8 percent as of end March 2022 and
retail/SME demand has resumed and capacity utilisation has improved which has
led to normalization of loan growth at Indian banks.”
The government has shown strong intent to push structural
reforms. The policy reforms have been meaningful, starting with the significant
reduction in the corporate tax rate, the introduction of fiscal incentives
under the PLI schemes for the manufacturing sector, expansion of public
infrastructure spending and opening up of new sectors for private businesses.
The recent spate of supply-chain disruptions in the wake of
the coronavirus pandemic and geopolitical tensions have brought to the fore the
vagaries of dependence on a few sources of supply. Global companies are making
a shift toward a “China plus” strategy to reduce their dependence on
that country and India is one of the biggest potential beneficiaries of the
“Indeed, we are seeing signs of improvement in foreign direct
investment (FDI) flows, multinational corporation (MNC) sentiment and more news
flow suggesting India should benefit from relocation of supply chains,” the
investment bank added.
It expects India’s export market share to more than double to
4.5 percent by 2030 from 2.2 percent currently.
After the pandemic brought the global economy to a standstill,
the complete reopening of the economy is enabling a strong recovery in India.
The recovery has been the strongest in almost a decade. “It is
the breadth of the recovery where we are seeing growth firing on almost all
cylinders, which is very encouraging,” said the report.
The strength of the economy can also be gauged from the
improvement in key economic indicators like the Composite Purchasing Managers’
Index (PMI) and a surge in Goods and Services Tax collections.
Growth in car and two- wheeler sales compared to pre-COVID
levels has been more than 30 percent each, new property sales and launches have
reached 11- and 8-year highs respectively and capacity utilisation rose to 75.3
percent in the first quarter of the current financial year.
According to Morgan Stanley’s proprietary MNC Sentiment Index,
which has a strong association with FDI inflows, corporate profits and the
direction of share prices, the sentiment towards India is close to all-time
“Relative to China, where we run a similar index, India took
its outperformance to an all-time high,” it added.
The report stated that from a geographical perspective, the
improvement in sentiment was led by the US and Japan. From a sector
perspective, real estate, materials, communication services and industrials
outperformed, whereas energy, utilities and consumer staples and technology
were the laggards.
The investment bank estimates that the overall investment rate
will rise to 36 percent of GDP by FY27 from around 31 percent of GDP in FY22.
This implies that total investment growth (nominal) will average around 16.7 percent
in the next five years compared to average growth of 8.8 percent in the
previous five years.
Risks to the banks’ outlook emerge from external factors such
as a sharper-than-anticipated slowdown in global growth and or a sharp rise in
commodity prices, particularly oil prices, which can impact business
Corporate profits still have steam left to go grow for the
next few years. The most important ingredient in profits is the rate of
investment. In turn, higher profits drive investments, creating a virtuous
cycle of higher wages, more consumption, more investments and more profits.
“The profit cycle breaks when investments start getting
unproductive or “excessive” but that point is a few years away,” said
the investment bank. “As investments rise, profit share in GDP (aka profit
margin) will likely go past its previous high which means Indian stocks are not
as rich as they appear on a headline basis.”
Given the perception that growth may be accelerating, led by
investments, Morgan Stanley thinks domestic cyclical sectors could do well
relative to external-facing sectors or defensive ones.
“Accordingly, we prefer industrials, financials and consumer
discretionary. We are also overweight on these sectors in our sector model portfolio
with a 12–18-month view,” it said.
Industrials are likely benefiting from strong capex plus
inexpensive valuations, while for financials, rising interest rates support
margins, low leverage levels in the economy and rising capex favour a loan boom
and benign credit costs further boost earnings.
Consumer discretionary valuations look attractive, given
expectations of strong growth in the coming months. Long-term fundamentals are
robust, underpinned by rising incomes.
Written by Gaurav Sharma
This article first appeared on the Moneycontrol