Animal Spirits: Udayan Mukherjee on India as the fastest-growing economy and its resilient stock market

It was way back in 1970 that the singer Kris Kristofferson coined the phrase ‘cleanest dirty shirt’ for one of his best-known songs, though it may be remembered better today as a Johnny Cash hit. Over the past decade, it went on to become a bond market classic, used by superstar bond fund managers like Mohamed El-Erian and Bill Gross. Of course, they used it to describe the US market, in the midst of a flailing global economy. Today, they would be hard-pressed to make such tall claims, with the US appearing to be no better than a soiled, stinking rag. Most people in the business world agree rather that the epithet now sits more easily on the shoulders of India, the new kid on the block.

Just look at the evidence. Over the past year, the Sensex is down only 3 per cent, at the time of writing this piece. During this period, the mighty S&P 500 in the US is down 25 per cent and the Nasdaq, 35 per cent. The MSCI Emerging Markets index is down a staggering 30 per cent, with China plunging 17 per cent. And the stock markets are only pricing in hard economic realities. In 2023, China will be lucky to grow at 4 per cent, Japan 2 per cent, and the US, the UK and Europe will likely all be in recession, while India may still grow at over 6 per cent. This makes us the fastest-growing of the large global economies, and understandably the most resilient stock market this year. Not without its own problems though and, therefore, the cleanest dirty shirt.

Some commentators have gone to the extent of suggesting that India will soon emerge as an ‘asset class’ on its own without any connection to the overall emerging market universe. An interesting premise, though not supported yet by the size of India’s free-float market capitalisation. After all, a market has to be big enough to absorb that significant an amount of foreign investor inflows. It will take time. Also, while India’s relative strength is indisputable, foreign institutional investors (FIIs) have not matched their vocal praise for the country’s economy with hard dollars. In the previous year, FIIs have actually sold a staggering Rs 3.8 lakh crore worth of Indian shares. This may be on account of the general global turmoil, the strength of the dollar versus the Indian rupee, or concerns on Indian valuations, but it isn’t exactly a great endorsement of a new ‘asset class’.

There are two ways this ‘cleanest shirt’ situation could play out from here. First, the optimistic path. In this, the currency is crucial. India’s external accounts situation cannot spiral out of control from here on. There are many unpredictable moving parts to this: the price of crude, which in turn depends on how the Russia-Ukraine war evolves; dipping exports because of a global recession; and global fund outflows if markets go into a tailspin. If somehow, these factors remain only in a zone of modest discomfort, no more, we could pull it off. In this scenario, we get hurt because of our global linkages, yet stand out tall in a relative sense, simply because all other large economies appear mired in economic gloom. Matters are helped by the fact that a new credit cycle propels Indian companies to expand their light balance sheets, further highlighting the growth differential with their global counterparts. In such a situation, India’s lofty valuations may yet sustain. Remember 2018, the year of GAAP—growth at any price? Then, a club of 10 stocks kept climbing higher, regardless of eye-watering PE multiples, simply because there was nothing else to buy.

Think of a global economy that way, where there are only a few countries to back, and it seems possible that such a narrow universe could be India’s friend. Almost as if India becomes the equivalent of a 2018 Asian Paints stock, defying a struggling broader market.

Now, the ‘not-so-optimistic’ scenario. Gloom is easier to predict in a world full of lunatic politicians and incompetent central bankers. The war takes an uglier turn, though one dreads uttering the N-word. Crude goes back to $140 a barrel. Inflation spikes further, and the US Fed slams the rate accelerator. India has no option but to follow, if only to protect the rupee. Global markets panic, the rupee tumbles to 90 to a dollar, FII outflows surge. In such a scenario, the very resilience we are celebrating today becomes our foe, as the valuation premium with other markets sticks out like a sore thumb. All this may sound alarmist, but entirely within the realm of possibility, dependent as it is on just a couple of wrong steps from the protagonists of this horror story.

Either of these two scenarios could play out, but as always, it is more likely that the outcome will be a ‘middle’ one, with some elements of each coming to pass. Maybe it is the festive cheer, but I am inclined to believe that more of the optimistic combination may play out than the pessimistic one. True, some of it is beyond our control, but even so. The key question remains: what should the Indian investor do, with so many risks on the horizon? At such times, it is always easier to use the analogy of stocks in a bear market. In a bad bear market, nothing is spared. Neither will we be, if things turn uglier globally. But when the bear market ends, it is the strongest stocks that bounce back first and the sharpest. It is then that one gets a glimpse of the leaders of the next bull run. The Nasdaq was the leader of the previous bull run, India could be one of the leaders of the next one. All signs, and even the price action, suggest that. It is just a question of gritting one’s teeth, and wading through this global bear phase. Do not for a moment presume that it will not inflict more scars by the time it is done, but the ones who are patient and use the pain to build their portfolio, will have the last laugh.

I could be horribly wrong, but one is allowed an error of optimistic judgement on the eve of Diwali, surely?