India To Extend Leadership Among EM Peers As Stock Market Boom Continues

India will extend its leadership position in MSCI's gauge for emerging markets Investable Market Index after recently pipping China which could attract foreign inflows amid peak valuations.

India is now the largest EM market per MSCI IMI (investible large, mid and small cap) criteria whilst China's weight has fallen by a half since peaking in early 2021, Morgan Stanley said in a note on Sept. 17.

India is now the sixth largest market globally, narrowly behind France, the brokerage said.

India will continue to gain share due to market outperformance, new issues and liquidity improvements, Morgan Stanley said. It remains 'overweight' on India and 'underweight' on China in its pan-Asia EM asset allocation.

India's nominal GDP growth rate is running in the low teens currently which is more than three times that of China, equity strategists at Morgan Stanley said. "This is generating a profound divergent operating and earnings growth environment for companies between the two geographies."

India's extending its leadership position comes at a crucial time as the US Federal Reserve is expected to cut its key rates to engineer a soft landing. Traders are pricing in a half-point cut even when the latest retail sales came higher than expected.

The rate cuts by the US central bank could add inflows to emerging markets with India expected to garner the most among them.

India could soon top China in the MSCI's gauge for emerging markets given that the gap is narrowing since 2020.

China's influence in emerging markets has declined since 2020, when it accounted for 40% of the MSCI EM Index, while India's presence has grown steadily.

India's weightage in the EM gauge jumped to a record of 19.4% from 18.8% in May, while that of erstwhile table topper China slipped to 24.2% from 25.4%, as per the index aggregator's quarterly review for August.

The MSCI Index—Morgan Stanley Capital International Index—is a benchmark for international investors, reflecting the performance of companies. Foreign institutional investors are significantly influenced by this gauge when making decisions to allocate capital to domestic stocks.

What could potentially weigh in on the sentiment is the valuations at which the domestic stocks are trading. India continues to be most expensive market among its emerging peers.

The broader market in India is more expensive than the benchmark indices. The price-to-earnings ratio of the Nifty is valued at 24.4, while that of the small-cap and the mid-cap index is at 34.5.6 and 46.8.

Earlier this month, analysts at Morgan Stanley said that India's bull run is only past the halfway mark but may see some profit booking in the short run.

India's benchmark indices—the NSE Nifty 50 and the S&P BSE Sensex—have risen 16.3% and 14.3%, respectively, so far this year, making them the fifth and sixth best-performing Asian indices.

(Correction: The story is corrected to reflect the correct name of the index.)