As the economy steadies, India hits a record high on a key emerging market index

India’s stock indices will most likely continue to rise next year, too, if the country’s growing weightage in the Morgan Stanley Capital International Emerging Market equity index is anything to go by.

The country’s share in the widely-tracked measure, which captures large- and mid-cap companies, has now risen to a record high of 12%.

Countries with a larger weightage than India’s include China, Taiwan and South Korea.

The index is key for institutional investors eyeing equities in 27 emerging market economies. It is likely that foreign investments flowing into a country are correlated to the country’s weightage in the index.

On November 12, Morgan Stanley Capital International, in its semi-annual review, added seven stocks to its India index. These were Godrej Consumer Properties, IRCTC, SFR, Zomato, Tata Power, Mindtree and Mphasis. This makes way for foreign fund inflows of about $1.4 billion into these seven stocks by the end of this month.

On the other hand, Morgan Stanley Capital International removed IPCA Laboratories and REC from the list. These changes will come into effect from November 30.

Yet, it may not exactly be a free run for the Indian stock market.

What lies ahead

Morgan Stanley believes that the Sensex, which closed at 58,465 on November 22, could hit 70,000 next year if India evades the third wave of Covid-19 or any further lockdowns.

Many international brokerages have, however, flagged India’s expensive valuations and inflationary pressures as matters of concern. “We are suggesting caution over a one-year time horizon as far as [equity] investments are concerned,” Vinit Sambre, head of equities of DSP Mutual Fund, told ETMarkets.

Higher commodity prices are expected to put pressure on input costs at factories in the first few months of 2022. Eventually, this will spill over into core inflation, the measure representing the long-run price trend, according to Arun Singh, global chief economist of Dun and Bradstreet.

“As prices, in general, are expected to go up, driven by supply disruptions and rising commodity prices, both consumer spending and corporate earnings are at risk,” Singh added.

Another deterrent factor is the approaching rate hike cycle. The Reserve Bank of India is expected to raise interest rates early next year, according to Morgan Stanley, which is likely to push up the cost of borrowing. This, in turn, may eat into corporate profit. Equities are then unlikely to give high returns.

Foreign fund inflows

India, due to its high growth potential, relatively lower wages, special investment privileges like tax exemptions, enjoys preference over other emerging economies.

The country’s real gross domestic product is projected to grow by 9.24% this year, and by 8.4% in 2022 – the fastest among all other major economies across Asia, according to data analytics company GlobalData.

“As Indian companies shift to adopt green technologies, capacity expansion plans, product development and the offering of new services are growth opportunities which can aid faster economic recovery in the coming quarter,” Gargi Rao, economic research analyst of GlobalData said.

Foreign investors have been making a beeline for India in the past few years, in Indian share markets as well as direct investments into corporates. Foreign institutional investors have sought out initial public offers, acquisitions, stake purchases, and so on. According to the National Securities Depository, foreign institutional investors have poured in $14.5 billion this year so far, compared to the $7.9 billion 10 years ago.

Morgan Stanley expects a full-fledged growth recovery for India’s economy, underpinned by rising exports and consumer demand.

“We believe that a pickup in investments underpinned by structural reforms will help to create a virtuous cycle of sustained high productivity growth,” it said.

This article first appeared on Quartz.