UBS’s recent report (Jan-2025), led by Manik Narain, highlights a significant structural slowdown in India’s economy, prompting the bank to recommend investors short the Indian rupee and adopt an underweight position in Indian equities.
This assessment comes as India’s economy, valued at approximately $4 trillion, experiences a decline that cannot be solely attributed to cyclical factors such as oil price fluctuations or decreased government spending.
Key Findings from UBS’ Report
Structural Slowdown
The report asserts that India’s economic deceleration is rooted in long-term issues affecting credit growth, foreign direct investment (FDI), export competitiveness, and overall earnings potential. This downturn is expected to worsen with external pressures, particularly from the United States under Donald Trump’s administration.
Market Impact
Indian stocks have seen a dramatic loss of nearly $500 billion in market capitalization recently, marking one of the worst starts to a year for the MSCI index since 2016. The rupee has consistently hit record lows against the dollar, making it the worst-performing currency in Asia during this period. Additionally, the country’s bonds are experiencing significant outflows as investor enthusiasm wanes.
GDP Growth Concerns
The report notes a concerning trend of declining real GDP growth, which has slipped below the pre-COVID average of 7%. This decline is further exacerbated by disappointing corporate earnings reports and a decade-long trend of companies failing to meet profit expectations.
Long-Term Factors Influencing the Slowdown
Credit Growth Moderation
UBS forecasts that sustainable credit growth in India will decrease from an average of 16% to about 10% annually. This shift is attributed to a high loan-to-deposit ratio of 80%, suggesting that future credit conditions will depend heavily on deposit growth to mitigate non-performing loans.
Chinese Economic Pressures
The depreciation of the Chinese yuan and reduced export prices are increasing competition for Indian industries, particularly in global markets. Despite recent rupee declines, it remains overvalued compared to historical averages.
Declining Foreign Direct Investment
FDI has drastically reduced to only $3 billion over the past year, raising alarms about stagnating equity investments amid broader economic pressures.
Market Participation Dynamics
Analysis reveals that equity investments constitute a substantial portion of Indian households’ financial assets (23%) and bank deposits (60%), indicating that the market can no longer be viewed as ‘underpenetrated’.
Valuation Concerns
Indian stocks are trading at a 72% premium compared to other emerging markets, an unprecedented valuation level even when factoring in recent market dynamics.
Sectors Most Impacted by India’s Economic Slowdown
Manik Narain identifies several specific sectors in India that are notably affected by the ongoing structural slowdown:
Consumer Staples
The consumer staples sector, traditionally viewed as defensive, is experiencing a moderation in earnings growth. This indicates that even essential goods are not immune to the broader economic challenges, suggesting that temporary factors like government capital expenditure are not solely responsible for the downturn.
Retail Sector
Within retail, particularly in fast-moving consumer goods (FMCG), growth has become muted. The shift towards digital commerce and quick delivery services is impacting traditional retail channels, leading to stagnation in sales growth for many established players.
Credit Markets
The overall credit environment is tightening, with sustainable growth rates expected to decline significantly. This impacts various sectors reliant on credit for expansion and operations, further exacerbating the slowdown across industries.
Export-Driven Industries
Competition from cheaper imports and a depreciating yuan is putting pressure on Indian industries that depend on exports, making it harder for them to maintain profitability and growth.
Foreign Direct Investment (FDI)
The decline in FDI, which has dropped to just $3 billion over the past year, signals a lack of investor confidence and impacts sectors reliant on foreign capital for growth and development.
These sectors reflect the broader economic challenges India faces as it navigates this structural slowdown, affecting both growth prospects and investment sentiment.
Policy Implications and Recommendations
The Reserve Bank of India (RBI) faces a challenging situation regarding interest rate policy. High US interest rates complicate potential monetary easing as it may undermine capital inflows at a time when FDI and equity investments are lacking. Narain emphasizes that while the economy requires stronger support for growth, any rate cuts could adversely affect the rupee’s stability.
UBS recommends investors consider bearish options on the rupee, anticipating an additional depreciation of approximately 2.6% within the year. Furthermore, they suggest adopting rate-receiver positions through five-year swaps to benefit from a projected 75 basis-point rate cut in the future.
In summary, UBS’s report paints a concerning picture of India’s economic landscape characterized by structural challenges that warrant caution among investors regarding both currency and equity exposure.