India set for cyclical earnings upswing, may outperform EM peers despite valuation concerns: Jonathan Garner, Morgan Stanley

India's economic trajectory has long been a subject of global attention, especially given its demographic dividend and growing market. The recent forecast by Morgan Stanley's analyst Jonathan Garner, predicting a cyclical earnings upswing for India and its outperformance over emerging market (EM) peers in the next two years, underscores this optimism. To truly grasp the significance of this forecast for competitive exams, it's essential to delve into its various facets.

At its core, a "cyclical earnings upswing" refers to a period where corporate profits are expected to grow significantly, following a period of slower growth or contraction, driven by broader economic improvements. This upswing is cyclical because economies naturally move through phases of expansion and contraction. For India, this prediction comes after a period marked by global economic uncertainties, including the lingering effects of the COVID-19 pandemic, supply chain disruptions, elevated global inflation, and geopolitical tensions. These factors had previously led to concerns regarding India's growth momentum and contributed to Foreign Institutional Investor (FII) outflows, as investors de-risked their portfolios from emerging markets.

Jonathan Garner's optimism is rooted in several key drivers. Firstly, "easing policy" refers to both monetary and fiscal measures. On the monetary front, the Reserve Bank of India (RBI), through its Monetary Policy Committee (MPC), has been carefully managing inflation while also supporting growth. While interest rates were hiked to tame inflation in previous periods, the expectation of 'easing' suggests either a pause in hikes or potential cuts in the future, which would reduce borrowing costs for businesses and consumers, stimulating economic activity. On the fiscal side, the government's continued focus on capital expenditure (capex) is a significant booster. The Union Budgets of recent years, particularly the one for 2023-24, have allocated substantial funds towards infrastructure development, with a 33% increase in capital outlay to ₹10 lakh crore (approximately 3.3% of GDP). This government-led capex is expected to crowd-in private investment, leading to a broader "capex revival."

This revival in capital expenditure is crucial because it creates jobs, boosts demand for raw materials and services, and enhances the productive capacity of the economy. Coupled with this, "stronger earnings growth" implies that Indian companies are expected to report robust profits, driven by increasing demand, improved operational efficiencies, and a favorable policy environment. This profitability is then expected to translate into higher stock market valuations, attracting both domestic and foreign investors. Sectors identified as key beneficiaries – financials, industrials, and consumption stocks – are typically the bellwethers of economic health. Financials benefit from increased lending and economic activity, industrials from infrastructure and manufacturing growth, and consumption stocks from rising disposable incomes and consumer confidence.

Key stakeholders in this scenario include the **Government of India**, whose fiscal policies, infrastructure push (like the National Infrastructure Pipeline and PM Gati Shakti initiative), and ease of doing business reforms are foundational. The **Reserve Bank of India (RBI)** plays a critical role through its monetary policy decisions, influencing interest rates and liquidity. **Indian Corporates and Businesses** are central to driving earnings growth and private sector capex. **Foreign Institutional Investors (FIIs) and Foreign Portfolio Investors (FPIs)** are crucial for capital inflows; their sentiment dictates market liquidity and valuation. Finally, **Indian Consumers** drive demand, which is a significant component of GDP growth. Investment banks like Morgan Stanley, through their research, act as influential voices guiding global investment decisions.

For India, this forecast holds immense significance. Economically, a sustained earnings upswing and outperformance against EM peers can lead to higher GDP growth, job creation, and improved living standards. It reinforces India's position as a preferred investment destination, potentially attracting more Foreign Direct Investment (FDI) and FII inflows, strengthening the Indian Rupee, and improving the balance of payments. Politically, a strong economy provides the government with greater fiscal space to implement social welfare programs and achieve developmental goals. Socially, sustained growth is critical for poverty alleviation and equitable development, aligning with Directive Principles of State Policy (DPSP) like Article 39, which mandates the state to direct its policy towards securing economic justice and preventing concentration of wealth.

Historically, India has witnessed several economic cycles. The post-liberalization era of 1991, marked by significant economic reforms, ushered in a new phase of growth and integration with the global economy. While India has faced global crises, its domestic consumption-driven economy has often provided a degree of resilience. This forecast comes at a time when global supply chains are being re-evaluated, offering India an opportunity to become a manufacturing hub, supported by policies like 'Make in India' and Production Linked Incentive (PLI) schemes.

Looking ahead, the future implications are substantial. If the forecast materializes, India could solidify its position as one of the fastest-growing major economies, potentially accelerating its journey towards becoming a developed nation. However, challenges remain, including managing inflation, ensuring inclusive growth, navigating global economic slowdowns, and effectively implementing reforms. The government's continued commitment to fiscal prudence, as enshrined in the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, and the RBI's independence in monetary policy under the RBI Act, 1934, will be vital. The foreign exchange management is governed by the Foreign Exchange Management Act (FEMA), 1999, which regulates capital account transactions and impacts FII/FPI flows. This positive outlook, despite valuation concerns, suggests a long-term confidence in India's structural growth story, driven by domestic demand, demographic factors, and ongoing policy reforms.