India has left behind the emerging market by a wide margin over the past few years in terms of stock market growth rate. The Indian market weight in the emerging market basket has almost doubled from 8.1% in October 2020 to 14.8% now. India remains the most bought emerging market with the highest projected GDP growth rate but recently we have been hearing a lot of murmurs about India’s valuation being too pricey compared to the emerging markets. Let’s dissect this.

Performance

The Indian market has indeed grown at a much higher pace than the emerging market basket. While the emerging markets on the whole have corrected 20% this year, India still remains almost flat.

MSCI EM Weights

India’s weight has steadily grown from 8% 2 years back to 14.8% now. We now have reached the second spot in the EM index surpassing Taiwan. This trajectory is fascinating and speaks volumes about the strength of the Indian markets and their projections.

Inflation

While the biggest struggle that the world is facing right now is inflation, Indian Inflation remains quite close to our target rate of 6%. Other emerging markets have a much lower inflation rate which is understandable as many of them are commodity-producing nations. The biggest eye sore in terms of inflation still remains the US market.

GDP Growth Projections

The International Monetary Fund (IMF) on Tuesday lowered India’s gross domestic product (GDP) growth projection for 2022-23 to 6.8% from the earlier 7.4%, citing the impact of a slowing global economy, stubborn inflation, rising interest rates and the war in Ukraine. But still, India remains the fastest-growing EM nation and this projection can explain the equity premium.

Valuation

Valuations are the biggest worry for India in comparison with the world. Driven by a rally in Indian stocks over the past year, the valuation of the MSCI India Index, in price/earnings terms, is trading at a 134% premium to the MSCI Emerging Market (EM) index, which is above the historical average of 62%.

Does India deserve a premium valuation?

There are various reasons why India is commanding a premium in valuation:

• India is very different from many of the EM nations like Brazil or Russia and South Africa. While Indian companies represent a set of diverse businesses which are high quality and high ROE, the other EMs are predominantly commodity driven.
• India is quite ahead of many emerging markets in terms of ownership, governance and transparency

On the other hand, we have seen the Indian market miss in terms of earnings by 4% last quarter and in such scenarios, valuation can become a concern.

Closing Thoughts

While we are quite sure about the strength of the Indian market and can justify its over-valuation, we are also sure that the valuation comparison is something that we shall hear a lot in the coming days.

But as the market cycle shifts from a highly inflationary environment to a low inflation one, the emerging markets might start shining soon and India being the second largest country in the Index will make bring cheer to our markets.