Markets
As Nifty eyes new highs, India’s valuations become a sore point
Summary
India’s equity valuations measured using the market capitalization to GDP (gross domestic product) ratio is above its long-term average. Also known as the Warren Buffett indicator the measure stood at 95% in FY23, showed an analysis by Motilal Oswal Financial Services Ltd.Benchmark Nifty 50 index is slowly striving to reclaim its all-time closing high of 18,813 seen in December 2022. On Thursday, the index closed just a percent away from that level. But valuations are getting steeper.
India’s equity valuations measured using the market capitalization to GDP (gross domestic product) ratio is above its long-term average. Also known as the Warren Buffett indicator the measure stood at 95% in FY23, showed an analysis by Motilal Oswal Financial Services Ltd. This is well ahead of its long-term average of 81%. This ratio is derived by using the total market cap of a country’s listed stocks as the numerator and GDP as the denominator.
“The market cap-to-GDP ratio shows that currently, India is not a cheap market, valuati-ons wise. This ratio tends to remain elevated when market is doing well. Note that Nifty 50 is likely heading to new highs," said Deepak Jasani, head of retail research at HDFC Securities Ltd.
It is worth nothing that recent return of foreign institutional investors into Indian equities has accelerated market momentum. “Mcap-to-GDP ratio is not flashing red yet—reading above 100% could be worrisome. At peak in December 2007, we have seen this yardstick climb to 153%. Even so, India is an expensive market," said Vinod Karki, head of strategy at ICICI Securities Ltd.
As such, post the recent rally, the upside in Indian markets could be limited. “Transition from an environment of abnormally low interest rates to normal levels of interest rates in developed markets may limit high returns from risk assets like equity," said Karki.
Meanwhile, the widely followed valuation metric—the price-to-earnings (PE) ratio is also showing caution. At a one-year forward earnings estimate, MSCI India index is trading at a multiple of 18.54x, showed Bloomberg data. This is a premium to MSCI Emerging Markets and MSCI Asia Ex-Japan indices, which are both 11x each.
That said, there are potential downside risks that could put India’s rich valuations to test. For one, exports could face some heat if global economy slips into a recession. Secondly, inflation measured via consumer price index is seen easing further thanks to transmission of interest rate hikes, but how monsoon pans out is critical. “While India Inc. posted a decent show in March quarter, deficient rainfall due to El Niño could dampen rural income, and that is a near-term risk to watch out for," Karki said. Further, consumption demand has been sluggish and recovery here would be closely tracked.
