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India's Fiscal Future: Analysing India’s upcoming Investment Opportunities & Risks in Light of New Fiscal Directions

The Lok Sabha elections, culminated in June'24. The exit polls had predicted a massive victory for the NDA with the BJP expected to cross the majority mark on its own. 

However, the BJP won far fewer seats as against expectations, and although the NDA secured majority and formed the government, it was a return to coalition politics after a decade. 

The equity market witnessed sharp correction on the date of the verdict but bounced back remarkably well in the subsequent few days. This implies that the market expects the policy agenda of the Govt. to continue, albeit with some tweaks.

While the broad thrust on capex and investment-led growth is expected to continue, the agenda going forward could also include some populist measures for reviving rural demand. The upcoming Budget would provide clarity on the path of fiscal consolidation.

Here’s a concise overview from our research desk, highlighting the key metrics shaping the momentum outlook...

India's Macroeconomic Landscape

India's economy has demonstrated remarkable resilience, with real GDP growth exceeding expectations in FY24. However, there are signs that the growth momentum may be slowing, presenting policymakers with the challenge of sustaining high growth rates amid domestic and external headwinds.

India’s GDP Outlook 

India's real GDP growth in FY24 was the highest since FY17, primarily driven by a surge in investment, while private consumption remained relatively subdued. Real GDP growth was significantly higher than anticipated, reaching 7.8% in 4QFY24, compared to 8.6% (revised up from 8.4%) in 3QFY24 and 6.2% in 4QFY23. Despite this impressive headline growth, underlying weaknesses in the economy remain.

High-frequency indicators suggest that economic activity may be losing steam, with the Economic Activity Index (EAI) GVA decelerating to an 18-month low in April 2024. EAI-GVA for April 2024 decelerated to an 18-month low, and selected high-frequency indicators (HFIs) for May 2024 also depict a weak growth outlook. Consequently, real GDP growth may moderate in FY25, potentially falling short of the central bank's projections.

India’s Capex Infusion 

The investment landscape presents a mixed picture. While total investments as a share of GDP reached a nine-year high in FY24, driven by a surge in government capital expenditure, corporate capex growth slowed sharply. Compared to an average of 3.6% of GDP in the 2010s decade, fiscal investments were 5.2% of GDP in FY24, marking new peaks for both central (2.7% of GDP) and state (2.6% of GDP) capital expenditures.

The government's efforts to boost infrastructure spending are commendable, but the private sector's reluctance to invest remains a concern.

Private Consumption and Household Sector 

Private consumption, a key driver of economic growth, remained subdued in FY24, although there were signs of a pick-up in the fourth quarter. Household investments, primarily in residential real estate, also moderated after two years of robust growth, increasing by 10.7% year-over-year (YoY) in FY24, following an average growth of 29% in the previous two years. Reviving private consumption and household investments will be crucial for sustaining economic growth in the medium term.

Savings and External Sector 

A positive aspect of India's economic performance was the improvement in the gross domestic savings rate, which reached a nine-year high in FY24, driven by an increase in household financial savings. If these savings are channeled into productive investments, they could support future economic growth.

Indian Equity

Indian equity markets remained range-bound in May 2024 amid uncertainty surrounding the Lok Sabha elections, geopolitical tensions, and foreign outflows. The Nifty 500 and Nifty 50 indexes saw marginal gains of 0.73% and 0.03%, respectively. Midcaps outperformed small caps, with the Midcap index rising by 2.23%, while the Nifty Smallcap index fell by 1.27%.

Key Developments:

  • The RBI approved a transfer of Rs. 2.1 lakh crore as a dividend to the government for FY24, significantly higher than the budget estimate of Rs. 0.9 lakh crore, potentially boosting government resources.

  • India’s Q4 FY24 GDP growth stood at 7.8% YoY, above estimates, driven by the manufacturing and construction sectors. The RBI projects 7.0% GDP growth for FY25.

  • Foreign Portfolio Investors (FPIs) sold off Rs. 25,586 crore from domestic equity markets in May 2024, likely due to high valuations in certain sectors, election uncertainties, and global risk-off sentiment.

Corporate Earnings - Q4 FY24:

Q4 FY24 corporate earnings ended on a strong note, with widespread outperformance across sectors. Domestic cyclicals like Autos and Financials, along with Healthcare, Capital Goods, and Cement, drove the earnings beat. Nifty-50 earnings jumped 12% YoY. The Auto sector grew 32% YoY, led by Tata Motors, Maruti, and Bajaj Auto. BFSI grew 22% YoY, Healthcare posted a healthy 44% YoY growth, and Capital Goods recorded a strong 27% earnings growth. However, Metals and O&G dragged down the overall performance. Nifty delivered 24% EPS growth in FY24, with the EPS estimate revised up by 2.6% to Rs. 1,005.

Outlook & Portfolio Strategy:

India appears well-positioned with solid macroeconomic indicators, including 8.2% GVA growth in FY24, inflation around 5%, trade and fiscal deficits within limits, a stable currency, and strong corporate earnings. The long-term fundamentals and corporate earnings trajectory remain robust, despite potential near-term volatility due to election outcomes. Nifty trades at a 12-month forward P/E of 19.2x, a 6% discount to its historical average.

Portfolio Strategy:

Markets in the near term may be influenced by the outcome of the elections and the timing and quantum of interest rate easing both globally and in India. We recommend a cautious yet balanced strategy that can withstand turbulent times.

  • Investors with an appropriate level of equity allocation based on their risk profile should continue to remain invested.

  • If equity allocation is lower than desired, investors can increase their allocation by implementing a staggered investment strategy over 6 to 12 months for select mid and small-cap strategies, and over 3 to 6 months for large and multi-cap strategies.

Indian Debt 

News of the inclusion of Indian bonds in global indices starting from June 2024 has increased the pace of buying by foreign investors since October 2023. Demand from domestic long-term investors like PFs, insurance companies, and banks has also been buoyant.

Change in India's Sovereign Outlook:

S&P raised India's sovereign rating outlook to 'positive' from 'stable', citing the country's strong economic fundamentals. The rating remains at BBB-. An upgrade in rating is possible if India's fiscal trajectory stays on its stated path of consolidation.

RBI's Dividend Payout to the Government in FY24:

The higher-than-expected RBI dividend transfer of INR 2.1 lakh crore to the government in FY24 (compared to the budgeted INR 1.02 lakh crore) may create fiscal leeway for populist spending without jeopardizing the medium-term fiscal consolidation roadmap or increasing gross borrowings.

Fiscal Prudence:

The fiscal deficit for FY24 is at 5.6%, compared to the revised estimate of 5.8%, due to higher tax receipts and lower revenue spending. In the upcoming budget, markets expect the government to adhere to the medium-term fiscal consolidation roadmap of 4.5% in FY26, but with a populist bias.

Portfolio Strategy:

To improve the overall portfolio yield, consider allocating 30% to 35% of the fixed income portfolio to select high-yield NCDs, private credit strategies, and REITs/InvITs. For liquidity management or temporary parking, investments can be allocated to:

  • Floating Rate (minimum 9-12 months)

  • Arbitrage/Ultra Short Term (minimum 6 months)

  • Liquid (1-3 months)

  • Overnight (less than 1 month) strategies.

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