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What is the story about?
A reduction in long-term capital gains (LTCG) tax could improve sentiment among foreign investors, but it may not be enough to bring them back in large numbers, according to Sunil Tirumalai, EM Strategist at UBS Global Research.
“In our discussions with foreign investors, sometimes the LTCG issue does come up as one of the points where which is a pain point or a friction point when they invest in India… But I wouldn't bank on hope that that is the panacea and that's going to bring in a flood of foreign money coming in,” Tirumalai said.
India's valuation premium over emerging markets has fallen from around 110% in September 2024 to about 65%, according to UBS. However, that is still well above the 30-40% premium India commanded before the Covid-19 pandemic. “So, in absolute terms, India is still at a premium. It's not at a discount,” Tirumalai said.
Earnings growth also offers little reason to assume that India will stand out from other emerging markets. UBS expects dollar earnings for the MSCI India index to grow at an annual rate of around 10-12% in 2027 and 2028. Tirumalai said this was slightly below the growth rate in a typical year over the previous decade, excluding the Covid-disrupted years.
He placed India around the middle of the emerging markets pack in terms of earnings growth. Global liquidity pressures and fundraising by governments and corporates are also influencing investment flows, sometimes independently of company fundamentals.
The debate over a possible tax cut comes amid significant foreign investor outflows, with foreign portfolio investors (FPIs) having pulled out $32.5 billion from Indian equities this year.
At the same time, the government's ability to offer tax relief could be constrained by fiscal pressures. ICRA has estimated a ₹2.85 lakh crore fiscal shortfall, amid higher subsidy expenses and lower tax collections.
A tax cut could further affect government revenues and widen the fiscal deficit, even as lower oil prices and an improvement in global conditions could help support India's inflation outlook, borrowing costs and corporate earnings.
[faq type="interview" title="This is an edited transcript of the interview."][ques][/ques][ans][/ans][/faq][faq type="interview"][ques]Arguably, earnings growth has been very solid this quarter, across large caps, mid caps and the broader market. There are some pockets of weakness, of course, but generally, the performance has been strong. The problem has been flows, with a constant wave of selling by foreign investors. Is that problem starting to ease? What is your sense? What feedback are you getting, Sunil?[/ques][ans]I don't think there is an immediate end to the problem you mentioned. In fact, it's not just India that is facing this issue. We are seeing a fair amount of selling across emerging markets and Asia. You were just discussing some of the AI stocks in India that are selling off. This has been the case elsewhere as well. Even globally, stocks of companies that have been reporting decent earnings growth, free cash flow growth and capital returns to shareholders have been largely ignored by the market. There is a flight away from equities in general, and AI stocks in particular. India is caught in the middle of this trend.[/ans][/faq][faq type="interview"][ques]On the earnings front, you are saying that India is somewhere in the middle among emerging markets. What about valuations?[/ques][ans]India has de-rated. When I say de-rated, I am referring to relative valuations. If we take September 2024, the previous major peak, as the starting point, India's valuation premium over emerging markets was about 110%. It is now down to around 65%. That represents a significant de-rating. However, this is also the period when the earnings growth outlook for other emerging markets has improved. The major trade and earnings upgrade cycle in Korea and Taiwan had not started at that point, but it is now very much underway. If I compare this with the kind of premium India enjoyed before COVID-19, it was about 30-40%. In absolute terms, India is still trading at a premium. It is not at a discount. The premium has come down by almost half, but it is still double the level seen before COVID-19. That is how we look at valuations.[/ans][/faq][faq type="interview"][ques]How is earnings growth tracking in absolute terms? Relatively speaking, in the Asian and regional context, you said India is somewhere in the middle in terms of earnings growth momentum. But how is India's own earnings growth performing compared with its long-term average?[/ques][ans]It is largely in line with what we would have experienced, barring the COVID-disrupted years. When we look at it from a weighted average perspective, we use MSCI India for ease of comparison. It is a larger universe than the Nifty. On a weighted average basis, earnings are expected to grow at around 10-12% CAGR over the next two years, 2027 and 2028. I would say that is slightly lower than what a normal year over the last 10 years would have delivered. On valuations, India is probably close to or slightly above its long-term average.[/ans][/faq][faq type="interview"][ques]The 10-12% CAGR is in dollar earnings?[/ques][ans]Yes, dollar earnings CAGR.[/ans][/faq][faq type="interview"][ques]And what is the expected earnings growth for the Nifty 50 over the next two years? The 10-12% figure seems a little on the lower side.[/ques][ans]A lot of our time is spent on the MSCI universe because that is what fits with the foreign investors we speak to. My guess is that the Nifty should not be too different from that. It could be a couple of percentage points higher because of differences in index composition.[/ans][/faq][faq type="interview"][ques]There is hope that there could be some relaxation in long-term capital gains (LTCG) tax ahead of or around the Budget. Could that be the catalyst that brings foreign investors back, given that the macroeconomic environment is stable, the earnings season has been fairly decent and ground-level demand indicators remain resilient?[/ques][ans]In our discussions with foreign investors, the LTCG tax issue does sometimes come up as a pain point or a friction point when they invest in India. If the long-term capital gains tax is hypothetically brought down to zero, I think that would help sentiment in the short term. However, I wouldn't bank on the hope that this would be a panacea and bring in a flood of foreign money. There are other factors as well. Fundamentals need to be strong. You mentioned earnings growth. We track performance and fundamentals in India compared with other parts of the world, Asia and emerging markets. India is not alone in the kind of strength we are seeing. There appears to be a cyclical uplift, and this is an elongated cycle that is supporting many other markets as well. If we look at earnings upgrades, the growth being delivered by companies and earnings beats versus expectations, I would place India somewhere in the middle in a regional context. It is neither at the bottom nor at the top in terms of growth and earnings beats. However, flows are very different. I don't think flows are necessarily looking at fundamentals right now. There are several liquidity events taking place, including capital raises by corporates and fundraising by governments globally. These are distorting the way fundamentals are being assessed.[/ans][/faq][faq type="interview"][ques]Going back to the point about liquidity, money is being pulled in different directions. Governments are raising funds, there have been large technology IPOs, and Anthropic is also likely to consider an IPO around the middle or end of November. It is expected to be a very large issue, with a potential valuation of $85 billion to $95 billion. When this kind of capital is being absorbed globally, how do you see money moving across markets, and how much of an impact could these events have on liquidity and fundamentals?[/ques][ans]This is a key question that we are discussing and grappling with, including in our conversations with investors. Governments globally are running record deficits, which need to be funded. At the same time, the US is witnessing a once-in-a-generation scale of capital expenditure build-out, which is also absorbing a lot of money. If I focus only on the AI ecosystem, which includes model companies, hyperscalers, data center companies and upstream players such as semiconductor companies, the net funding requirement is much lower than what one might assume by looking only at hyperscalers. This is because semiconductor companies are generating significant cash flows. For instance, a couple of memory companies in Korea are expected to distribute $75 billion to $100 billion through buybacks or dividends this year. So, there is cash being returned from the other side as well. Assuming smooth equity flows across borders, the net funding requirement is much lower. We are probably looking at an annual free cash flow shortfall of around $150 billion for the AI ecosystem, which is a reasonably manageable number. It is not just the IPOs you mentioned. Listed hyperscalers could also start raising equity capital. This could lead to a crowding-out effect for other issuers, which is something we are clearly seeing in the fixed income market. In the US, some weaker issuers have seen their bonds sell off, while credit default swap (CDS) spreads have widened sharply. However, I think this is restricted to a few weaker credit issuers rather than reflecting broad-based concerns about the entire market.[/ans][/faq][faq type="interview"][ques]Out of the India coverage universe, could you briefly tell us which sectors offer the most attractive opportunities right now?[/ques][ans]Without getting into specific stock names, I think banks make a lot of sense to us. Banking is one of the few sectors trading at a significant discount to its own historical valuations. There have been several corporate and management-related developments in the sector, but if we assume that these issues have been settled, as our teams are also assuming, we can now focus purely on fundamentals. There is a lot of value to be found in banking stocks. Beyond that, there are specific themes and sectors worth looking at. For instance, there is a power shortage, and companies supplying products and services to the power and data center ecosystems could offer opportunities. There could also be opportunities in select consumption companies where there are strong competitive advantages and clear growth visibility.[/ans][/faq][faq type="interview"][ques]You have coverage on companies such as Sterlite and HFCL.[/ques][ans]I wouldn't want to get into specific stock names, particularly stocks that UBS does not cover. I would rather not comment on individual names.[/ans][/faq][faq type="interview"][ques]You mentioned suppliers to the power and data center ecosystems as two areas of opportunity.[/ques][ans]Yes, there could be other names as well.[/ans][/faq]
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“In our discussions with foreign investors, sometimes the LTCG issue does come up as one of the points where which is a pain point or a friction point when they invest in India… But I wouldn't bank on hope that that is the panacea and that's going to bring in a flood of foreign money coming in,” Tirumalai said.
India's valuation premium over emerging markets has fallen from around 110% in September 2024 to about 65%, according to UBS. However, that is still well above the 30-40% premium India commanded before the Covid-19 pandemic. “So, in absolute terms, India is still at a premium. It's not at a discount,” Tirumalai said.
Earnings growth also offers little reason to assume that India will stand out from other emerging markets. UBS expects dollar earnings for the MSCI India index to grow at an annual rate of around 10-12% in 2027 and 2028. Tirumalai said this was slightly below the growth rate in a typical year over the previous decade, excluding the Covid-disrupted years.
He placed India around the middle of the emerging markets pack in terms of earnings growth. Global liquidity pressures and fundraising by governments and corporates are also influencing investment flows, sometimes independently of company fundamentals.
The debate over a possible tax cut comes amid significant foreign investor outflows, with foreign portfolio investors (FPIs) having pulled out $32.5 billion from Indian equities this year.
At the same time, the government's ability to offer tax relief could be constrained by fiscal pressures. ICRA has estimated a ₹2.85 lakh crore fiscal shortfall, amid higher subsidy expenses and lower tax collections.
A tax cut could further affect government revenues and widen the fiscal deficit, even as lower oil prices and an improvement in global conditions could help support India's inflation outlook, borrowing costs and corporate earnings.
[faq type="interview" title="This is an edited transcript of the interview."][ques][/ques][ans][/ans][/faq][faq type="interview"][ques]Arguably, earnings growth has been very solid this quarter, across large caps, mid caps and the broader market. There are some pockets of weakness, of course, but generally, the performance has been strong. The problem has been flows, with a constant wave of selling by foreign investors. Is that problem starting to ease? What is your sense? What feedback are you getting, Sunil?[/ques][ans]I don't think there is an immediate end to the problem you mentioned. In fact, it's not just India that is facing this issue. We are seeing a fair amount of selling across emerging markets and Asia. You were just discussing some of the AI stocks in India that are selling off. This has been the case elsewhere as well. Even globally, stocks of companies that have been reporting decent earnings growth, free cash flow growth and capital returns to shareholders have been largely ignored by the market. There is a flight away from equities in general, and AI stocks in particular. India is caught in the middle of this trend.[/ans][/faq][faq type="interview"][ques]On the earnings front, you are saying that India is somewhere in the middle among emerging markets. What about valuations?[/ques][ans]India has de-rated. When I say de-rated, I am referring to relative valuations. If we take September 2024, the previous major peak, as the starting point, India's valuation premium over emerging markets was about 110%. It is now down to around 65%. That represents a significant de-rating. However, this is also the period when the earnings growth outlook for other emerging markets has improved. The major trade and earnings upgrade cycle in Korea and Taiwan had not started at that point, but it is now very much underway. If I compare this with the kind of premium India enjoyed before COVID-19, it was about 30-40%. In absolute terms, India is still trading at a premium. It is not at a discount. The premium has come down by almost half, but it is still double the level seen before COVID-19. That is how we look at valuations.[/ans][/faq][faq type="interview"][ques]How is earnings growth tracking in absolute terms? Relatively speaking, in the Asian and regional context, you said India is somewhere in the middle in terms of earnings growth momentum. But how is India's own earnings growth performing compared with its long-term average?[/ques][ans]It is largely in line with what we would have experienced, barring the COVID-disrupted years. When we look at it from a weighted average perspective, we use MSCI India for ease of comparison. It is a larger universe than the Nifty. On a weighted average basis, earnings are expected to grow at around 10-12% CAGR over the next two years, 2027 and 2028. I would say that is slightly lower than what a normal year over the last 10 years would have delivered. On valuations, India is probably close to or slightly above its long-term average.[/ans][/faq][faq type="interview"][ques]The 10-12% CAGR is in dollar earnings?[/ques][ans]Yes, dollar earnings CAGR.[/ans][/faq][faq type="interview"][ques]And what is the expected earnings growth for the Nifty 50 over the next two years? The 10-12% figure seems a little on the lower side.[/ques][ans]A lot of our time is spent on the MSCI universe because that is what fits with the foreign investors we speak to. My guess is that the Nifty should not be too different from that. It could be a couple of percentage points higher because of differences in index composition.[/ans][/faq][faq type="interview"][ques]There is hope that there could be some relaxation in long-term capital gains (LTCG) tax ahead of or around the Budget. Could that be the catalyst that brings foreign investors back, given that the macroeconomic environment is stable, the earnings season has been fairly decent and ground-level demand indicators remain resilient?[/ques][ans]In our discussions with foreign investors, the LTCG tax issue does sometimes come up as a pain point or a friction point when they invest in India. If the long-term capital gains tax is hypothetically brought down to zero, I think that would help sentiment in the short term. However, I wouldn't bank on the hope that this would be a panacea and bring in a flood of foreign money. There are other factors as well. Fundamentals need to be strong. You mentioned earnings growth. We track performance and fundamentals in India compared with other parts of the world, Asia and emerging markets. India is not alone in the kind of strength we are seeing. There appears to be a cyclical uplift, and this is an elongated cycle that is supporting many other markets as well. If we look at earnings upgrades, the growth being delivered by companies and earnings beats versus expectations, I would place India somewhere in the middle in a regional context. It is neither at the bottom nor at the top in terms of growth and earnings beats. However, flows are very different. I don't think flows are necessarily looking at fundamentals right now. There are several liquidity events taking place, including capital raises by corporates and fundraising by governments globally. These are distorting the way fundamentals are being assessed.[/ans][/faq][faq type="interview"][ques]Going back to the point about liquidity, money is being pulled in different directions. Governments are raising funds, there have been large technology IPOs, and Anthropic is also likely to consider an IPO around the middle or end of November. It is expected to be a very large issue, with a potential valuation of $85 billion to $95 billion. When this kind of capital is being absorbed globally, how do you see money moving across markets, and how much of an impact could these events have on liquidity and fundamentals?[/ques][ans]This is a key question that we are discussing and grappling with, including in our conversations with investors. Governments globally are running record deficits, which need to be funded. At the same time, the US is witnessing a once-in-a-generation scale of capital expenditure build-out, which is also absorbing a lot of money. If I focus only on the AI ecosystem, which includes model companies, hyperscalers, data center companies and upstream players such as semiconductor companies, the net funding requirement is much lower than what one might assume by looking only at hyperscalers. This is because semiconductor companies are generating significant cash flows. For instance, a couple of memory companies in Korea are expected to distribute $75 billion to $100 billion through buybacks or dividends this year. So, there is cash being returned from the other side as well. Assuming smooth equity flows across borders, the net funding requirement is much lower. We are probably looking at an annual free cash flow shortfall of around $150 billion for the AI ecosystem, which is a reasonably manageable number. It is not just the IPOs you mentioned. Listed hyperscalers could also start raising equity capital. This could lead to a crowding-out effect for other issuers, which is something we are clearly seeing in the fixed income market. In the US, some weaker issuers have seen their bonds sell off, while credit default swap (CDS) spreads have widened sharply. However, I think this is restricted to a few weaker credit issuers rather than reflecting broad-based concerns about the entire market.[/ans][/faq][faq type="interview"][ques]Out of the India coverage universe, could you briefly tell us which sectors offer the most attractive opportunities right now?[/ques][ans]Without getting into specific stock names, I think banks make a lot of sense to us. Banking is one of the few sectors trading at a significant discount to its own historical valuations. There have been several corporate and management-related developments in the sector, but if we assume that these issues have been settled, as our teams are also assuming, we can now focus purely on fundamentals. There is a lot of value to be found in banking stocks. Beyond that, there are specific themes and sectors worth looking at. For instance, there is a power shortage, and companies supplying products and services to the power and data center ecosystems could offer opportunities. There could also be opportunities in select consumption companies where there are strong competitive advantages and clear growth visibility.[/ans][/faq][faq type="interview"][ques]You have coverage on companies such as Sterlite and HFCL.[/ques][ans]I wouldn't want to get into specific stock names, particularly stocks that UBS does not cover. I would rather not comment on individual names.[/ans][/faq][faq type="interview"][ques]You mentioned suppliers to the power and data center ecosystems as two areas of opportunity.[/ques][ans]Yes, there could be other names as well.[/ans][/faq]
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