'Probability of sharp PE contraction': India's risk premium to US at 20-year low; what it means

India's 10-year bond yield spread over the US has narrowed to a two-decade low of 175 basis points, a level last seen in 2004–05. According to ICICI Securities, this reflects a declining risk premium for Indian assets. Combined with robust return on equity (RoE) and strong growth prospects, the brokerage sees limited risk of a sharp price-to-earnings (PE) multiple contraction in the current environment.

"The aforementioned trends indicate risk-premium for India is at an all-time low, thereby, warranting elevated P/E valuations for India, assuming relative macro strength continues," ICICI Securities said.

RoEs remain in the value-creating range — 15 per cent for India and 19 per cent for the US — while India is expected to deliver higher economic growth, the report noted.

ICICI Securities highlighted that India’s equity market is currently trading at 21 times forward earnings, on par with the US, and believes this valuation level is sustainable under current conditions.

However, the brokerage cautioned that geopolitical tensions in the Indian subcontinent could increase the equity risk premium, posing a risk to market valuations.

India’s 10-year bond yield has dropped more than 100 basis points over the past two years to 6.3 per cent, its lowest level in two decades, excluding crisis periods like the Global Financial Crisis and the COVID-19 pandemic. With US 10-year yields at 4.5 per cent, the current 175 bps spread is the narrowest in 20 years.

Further indicating lower risk premium, India’s credit default swap (CDS) spread relative to the US has dropped to a record low of 17 basis points—India at 78.6 bps vs the US at 61.5 bps—based on data since 2014.

ICICI Securities also observed shifts in sectoral market capitalisation. Over the past decade, India has lost share in tertiary and new-age sectors—such as technology, communications, and discretionary consumption—compared to the US and China. Meanwhile, it has gained in primary and secondary sectors like materials, industrials, utilities, energy, and financials.

"This reflects the evolving economic structure in these regions," ICICI Securities said. "China is transitioning toward tech-driven sectors, the US remains a leader in new-age industries, and India continues to rely heavily on its primary sector, with tertiary growth led by traditional financial and IT outsourcing services, while manufacturing has seen stagnation."