September 2022 / Q2 FY23

Over the last six months the Nifty Small Cap 100 corrected by roughly 10%, while about 50% of its constituents saw drawdowns ranging from -11% to -66%. Amid this broader sell-off, our portfolio continued to show strong resilience, beating the benchmark by roughly 20%.

The headline Nifty 50 showed a different picture, correcting by only 2% over the same six-month period, even as major global indices lost anywhere between -5% and -28%.

This outperformance of Nifty led to the catchphrase “India decoupling” once again. Our view is sharper: India is indeed decoupling, but from its own older self rather than from the world.

01Is India Decoupling? Yes, From Its Own Older Self

India seems to be going through a transformational change from its own old self, more particularly across three macro areas: domestic stock-market liquidity, political stability, and growing economic strength.

1AStock-Market Liquidity: Less Reliance on FII Flows

FIIs had sold roughly $27.4 billion of Indian stocks since October 2021. The last time India witnessed this kind of selling was 2008, when FIIs sold roughly $14.4 billion from January 2008 to February 2009 and the market crashed by about 55%.

This time, despite FII selling almost twice the absolute 2008 amount, markets had barely corrected by 3% because DIIs infused more than $41 billion into Indian equities[2]. Had this been the old India, the stock market would likely have corrected far more.

1BPolitical Stability and World-Stage Dominance

Over the last 30 years, coalition governments had become an accepted norm, often leaving weaker governments with limited resolve for significant reforms or a strong India image globally. The 2019 mandate changed that by giving room to push reforms such as GST, RERA, IBC, PLI schemes, Direct Benefit Transfer, and revocation of Article 370.

India has also improved its global relationships and bargaining position. In 2019 it exited the 16-country RCEP to avoid cheap-import pressure, then entered an FTA signing cycle: one FTA was completed with the UAE, while FTAs with the UK, EU, Canada, and Australia were under negotiation.

India’s Covid handling, vaccine and medicine supply, resistance to unfavourable economic decisions, and hard stand during the Russia-Ukraine war have all strengthened its global positioning. The push from “Jai Jawan Jai Kisan” to “Jai Vigyaan” and “Jai Anusandhan” has helped make the new India more self-confident and entrepreneurial.

1CEconomic Strength: Moving Beyond “Under-Developed”

In a growth-starved world, India was projected to be the fastest-growing major economy in 2022 (7.4%) and 2023 (6.1%), even as other global economies slowed, and had overtaken the UK to become the world’s fifth-largest economy[3].

India’s short-term debt was roughly 20% of total debt and the forex-to-total-reserve ratio stood at roughly 98%, suggesting no alarming immediate liability and enough reserves to cover a good part of debt in a liquidity squeeze[2].

GST collections had remained above ₹1.4 lakh crore for the seventh straight month. Direct tax collections surged 24% to roughly ₹9 lakh crore from April 1 to October 8, 2022, making up 52.46% of the total budgeted estimate for FY22-23.

02Can the Global Slowdown Impact This Decoupled India?

2AExports: A Mixed Bag

Even after posting a record $400 billion in merchandise exports in FY22, India still contributed barely 1.8% of global merchandise exports. Its target of $1 trillion in merchandise exports will face some slowdown impact, but from a small base the impact may not be deep: growth may dip, but growth should continue.

China+1 and Europe+1 should also open opportunities for Indian merchandise exports. The slowdown risk is that global customers may consolidate vendors, restricting opportunities to suppliers already credible in those geographies. For segments where India already has a leading share, such as IT services, home textiles at roughly 25% share, and gems and jewellery, global slowdown will be felt more sharply.

2BDomestic Demand: A Cushion Against Slowdown

India’s domestic consumption accounts for roughly 60% of GDP. Continued infrastructure spending and domestic-manufacturing policies therefore provide a large cushion against global slowdown.

For FY22-23, the government allocated roughly ₹7.5 lakh crore in capital expenditure. Centre capex as a percentage of GDP was expected to hit an all-time high, with a higher multiplier effect than revenue expenditure.

Engineering and manufacturing should benefit from large-scale projects announced by global majors such as Foxconn and Apple, plus policy initiatives including lower corporate tax for new manufacturing units, PLI, and PM Gati Shakti. India’s ease-of-doing-business rank improved from 142 in 2014 to 63 in 2022.

Chemical companies had corrected to more reasonable valuations. Many enjoy global leadership positions and are moving up the value chain. European players had benefited from low gas prices, but the energy crisis forced many plants to cut production of key chemicals by up to 50%, creating a Europe+1 opportunity alongside China+1.

India is the world’s largest arms importer, accounting for 11% of global arms sold. It is also the third-highest military spender, with a defence budget of roughly ₹4 lakh crore excluding pensions. The defence-manufacturing turnover target of ₹1.75 lakh crore by 2025 was being scaled toward orders of ₹8 lakh crore over the next eight years.

Agriculture was another domestic theme. Amid the Russia-Ukraine war, India focused on food security through bans on certain commodities such as rice and wheat. Its global food and agriculture trade share was only 2–3%, versus the EU at 50% and the US at 10%. Fertilizers, agrochemicals, piping, irrigation, solar panels and pumps should benefit from the need to improve yield per hectare and reduce subsidy pressure.

03How Is Our Portfolio Positioned?

Our portfolio is walking the talk: the opportunities we are looking at are focused on identifying sectors and companies expected to defy the gloomy global economic outlook.

Q1 performance of our portfolio companies was in line with our expectations given the volatile commodity environment and unstable geopolitical scenario. Excluding financials, our portfolio companies posted median Sales and PBT growth of 30% YoY. Median PAT growth was 19% YoY due to higher tax incidence in Q1.

We expect some margin volatility in Q2 for certain companies because of raw-material and currency fluctuations. However, H2 FY23 should be better as commodity prices stabilize, making demand more sustainable.

We continue to use market volatility to build our portfolio and look for newer opportunities that fit our investment philosophy. Lastly, we wish all our investors and well-wishers a very Happy Diwali and a Prosperous New Year.

Sources

01

Equitree Capital — internal performance records and index/portfolio tables as at 30 September 2022; signed Q2 FY23 newsletter source PDF.

02

Ambit Research; Equitree Capital Research — FII/DII flows, gross debt, forex reserves, banking asset quality, corporate debt, infrastructure order book and capex charts used in the September 2022 newsletter.

03

IMF — GDP growth projections cited in the September 2022 newsletter: India 2022/2023, major-country 2023E projections, and advanced vs emerging/developing economy growth estimates.

04

WTO; Morgan Stanley; Equitree Capital Research — India export-destination share in 2000 and 2021.

05

Edelweiss Research; SIPRI; Equitree Capital Research — capital goods order book and top military expenditure tables cited in the September 2022 newsletter.