Given India’s macro-economic resilience against a challenging global backdrop, domestic cyclical sectors in India will continue to perform better. Bank outperformance could continue on the back of strong earnings growth, driven by high-teen loan growth and stable margins next year. While the cost of funds for banks is likely to go up next year, amid rising deposit rates, banks should be able to maintain profitability due to a relatively stable funding profile, and ability to pass on higher costs in a strong credit growth environment.
Domestic conditions are also conducive for a capex cycle recovery over the next few years, as indicated by corporate deleveraging, recovering capacity utilisation, and ongoing government focus on capital expenditure, notably in the PLI-linked sectors. This should benefit a host of investment cyclical sectors related to manufacturing — such as infrastructure, construction and engineering, and allied industries including transportation, logistics and cement. In addition to capex recovery and Make-in-India (MII) themes, we like various intra-market alpha ideas including banks vs. non-bank financial companies (NBFC), staples vs. discretionary and rural vs. urban consumption.
Three India sectors you are bearish on and the rationale for each
NBFCs, Infotech and Consumer discretionary (retail, durables) could underperform next year. NBFC profitability is likely to come under pressure due to increase in borrowing costs, higher proportion of fixed rate portfolio and increasing competition across consumer lending. Moreover, consumer credit oriented NBFCs (personal loans, mortgages) are trading at rich valuations vs. mid-cycle multiples for banks, supporting our relative preference for banks over NBFCs.
For the Infotech sector, which has been the worst performing sector this year, we could see further USD revenue and earnings cuts for 2023, given the probability of significant growth slowdown in US and mild recession in Europe next year. Tech sector valuations are still above the long-term average and have not fully reflected the earnings cuts. Within the broad consumer sector, discretionary has generally outperformed staples over the past three years, since the pandemic began. This could reverse going into next year, given signs of a slowdown in middle income discretionary spending, rising competition from potential new entrants and elevated valuations for the sector.
Biggest positive catalyst/trigger in next one year
An improving global macro backdrop if the Federal Reserve goes on hold and the USD peaks, over the next 3-6 months would be a positive catalyst for India. A better global environment, coupled with improving growth in 2H22, could spur foreign inflows and support INR and equities. Over the medium term, higher capex spending and pick-up in manufacturing could boost India’s growth and further attract capital as global firms continue to pursue supply-chain diversification.
Biggest negative catalyst/trigger in next one year
Domestic flows have been supportive and have offset record foreign selling this year. Over the past six months, monthly domestic mutual fund inflows have halved amid rising retail deposit rates. We see potential risk of further slowdown in domestic equity inflows as deposit rates continue to rise next year, especially against a backdrop of expensive equity valuations and a decadal low equity/bond yield gap, meaning fixed income investments could appear more attractive than equities.
Sunil Koul, Asia Pacific Equity Strategist at Goldman Sachs, focusses on regional equity markets including coverage of India and Asian derivatives