India’s plan to spend its way out of the coronavirus shock has lent more power to stock bulls and shifted the debate away from valuations in one of Asia’s most expensive equity markets.

Stock watchers are now pondering how far the S&P BSE Sensex – which has already climbed more than 7 per cent in less than two sessions – can go. One estimate by Morgan Stanley sees the benchmark at 55,000 by end-2021, implying an upside of almost 11 per cent from current levels.

Meanwhile bond traders have been shocked by the plan to spend almost $500 billion. The key 10-year sovereign yield jumped by the most since May on Monday, putting pressure on the central bank to step in. The budget may further boost the appeal of Indian stocks for global funds, who have bought shares so far this year while selling local bonds.

“Government spending coupled with reforms and greater privatisation 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 a “superior earnings momentum especially if the budget is successful in reviving the investment cycle,” he said.

The Sensex has already wiped out the 5.3 per cent 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

Investor 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, 21 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 GDP, 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.

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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, portfolio 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 bonds rally in 2020, the budget may trigger a divergence in performance between the two asset classes. Both sovereign and corporate bonds sold off on Tuesday. Yields on top-rated rupee corporate notes rose as much as 15 basis points for one-, five- and 10-year maturities, traders said.

However, a lot depends on the extent of the Reserve Bank of India’s support measures. 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.

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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 RBI 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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