A 37% increase in the industry’s stock index may not seem the appropriate reaction to a year filled with challenges for the sector. But that’s how much the BSE FMCG Index has gained in the past year, despite the spillover effects of November 2016’s demonetisation, followed by the chaos wrought by the goods and services tax mid-year.

That consumption was the dominant theme of 2017 with investment-linked sectors taking longer to recover could be one reason. That the long-term consumer market remains healthy and will bounce back could be another. Investors appear to have stayed invested or added consumer stocks to their portfolio, in the hope of a sustained revival. So, 2018 could be seen as a year in which these expectations will be tested.

The developing signs are positive. The September quarter did see companies report rather decent sales growth rates, which was the first quarter after GST came into effect from July. Both urban and rural markets are recovering, although urban is doing better. If rural snaps into action, then growth rates in 2018 could swing up further.

The agencies that track the sector seem optimistic. Euromonitor expects Asia Pacific to drive consumer market growth between 2017 and 2030, pointing to the fact that although it contributes to half of global manufacturing, it has only a 27% share in consumer expenditure. It expects China and India to remain key contributors.

Nielsen Co. brought out a year-end note which talks about global FMCG markets strengthening. It is upbeat on India and says business is returning to normalcy and says the industry is encouraged by the government’s proactive moves to cut tax rates under GST. But that does not mean all companies will do equally well.

A size-wise analysis by Nielsen of September quarter growth shows overall FMCG retail sales grew by 14.1% (this can differ from the sales companies report), with the top five companies reporting 12.6% growth while the next five actually did much better, reporting 18.4% growth. The next 20 saw slower growth but impressively, the smaller companies as a whole seem to have done very well. So, while demonetisation and GST may have affected the unorganized segment, the organized but small players may be doing well. Although this is only one quarter’s numbers, the trends indicate that the smaller companies may be doing well also.

The December quarter should give the first signs of how the sector is doing, although this task will be made difficult by a low sales base due to demonetisation. Adjusted for that, a healthy revival in volume growth in both urban and rural areas is what we are looking for. On the macro front, if GDP growth revives, that should support a sustained revival. Rising inflation could become a problem and is a risk that bears watching. A little is good as it lets companies increase prices but too much will see consumers cut back on spending.

Lastly, valuations are expensive. The FMCG Index trades at a price-to-earnings ratio of 42 times its trailing four quarter earnings, compared to the broad market’s 25 times. That’s a lot of expectation that has been front-loaded. That also means the risks are more to the downside if the listed universe is unable to deliver the kind of growth the market is expecting.