Country Risk: A July 2023 Update - Daddy Tv

The monetary policy committee (MPC) has pegged its September 2022 quarter inflation estimate at 5%, and growth at 8%. We believe the latter can be higher than MPC’s forecast, and so, have been strong advocates of removal of policy accommodation. The RBI has already embarked on it, by raising the variable rate reverse repo by nearly 60 basis points since September, in the process triggering deposit rate hikes by banks and pushing the yields on the 10-year government bonds to pre-covid levels. The reason why it has chosen to not raise reverse repo rates is perhaps uncertainty around the Omicron spread, and on global growth. As India’s growth indicators stabilize, it can embark on normalization with a surer hand. Required return on equity can be computed using the model by incorporating the current price, which is observable, free cash flow to equity and long-term stable growth rate that are estimable.

1. You will notice that there are countries that are not rated (NR) that have equity risk premiums attached to them.
2. Against this backdrop, this article attempts to decompose equity price movements in India since 2005 to 2020 into contribution of changes in growth expectations, interest rates and Equity Risk Premium (ERP) using DDM.
3. This issue includes coverage of historical ERP using both Sensex and NIFTY50 indices.
4. This study is an extension of the first edition and builds on it by adding three years from the past (2017, 2018 and 2019) and the latest year (2023).

In our DDM framework, the value of equity benchmark Sensex is considered as representative price of Indian equities. Expected FCFE is assumed to be 60 per cent of expected net profits of constituent Sensex companies, which are derived using consensus forward earnings estimates of equity analysts for a three-year period (high growth phase) available on Bloomberg. Terminal growth rate is assumed to be equivalent to 10-year G-sec rate, which is also considered to be the risk-free rate. ERP serves as a key input in determining cost of equity and thus warrants the need for monitoring.

[iii] Volatility is computed as the annualized standard deviation of the returns from Nifty 500 and S&P BSE India 10 Year Sovereign Bond Index for the period 1 August 2011 to 1 August 2016. The fourth edition of Incwert’s India Control Premium Study, 2022 is an update to the previous year’s study. The study analyses 20+ years (March 2002 to June 2022) of premium offered in takeovers in public transactions which triggered open offer obligations on the acquirers. Unravelling the tapestry of royalty rates is our comprehensive study of intellectual property rates in India. In this study, we explore trends, challenges, and comparisons in the Indian royalty landscape over the last decade.

Purchase Price Allocation (PPA) Study, India

Since these other risks are so highly correlated with each other, for most counties, it is true that default risk becomes an reasonable proxy for overall country risk, but there are some countries where this is not the case. Consider portions of the Middle East, and especially Saudi Arabia, where default risk is not significant, since the country borrows very little and has a huge cash cushion from its oil reserves. Investors in Saudi Arabia are still exposed to significant risks from political upheaval or unrest, and may prefer  a more comprehensive measure of country risk. Central banks also monitor equity prices in pursuit of their objective of maintaining financial stability, which is a prerequisite for price and economic stability.

Broadly, there are three methods to compute ERP categorised into survey-based approach, ex-post calculation giving historical ERP and ex ante or implied ERP based on valuation models, which considers current market prices and interest rates. While the survey-based approach suffers from individual biases, historical ERP yields backward looking estimate. In this respect, implied ERP is considered a better indicator and is consistent with the generally accepted belief that return on equities is driven by market expectations. Implied ERP, calculated using this approach, is a forward-looking estimate of ERP and is consistent with the generally accepted belief that return on equities is driven by expectations. However, the reliability of implied ERP largely depends upon the accuracy of estimated future earnings, which may be subject to miscalculation and/or the bias of analysts. It is different from historical ERP that computes the premium over the risk-free rate earned by equity investors in the past.

The dividend yield of 1.24%[v], in our opinion, is not truly reflective of the potential earnings from the index. These premiums, however, suffer from one serious problem – the standard deviation of these averages is high so as to make their calculation meaningless. This issue includes coverage of historical ERP using both Sensex and NIFTY50 indices.

That said, CS Global strategists believe till a 3% level, equities don’t get negatively impacted. The first key determinant of ERP is the risk aversion of investors that suggest equity risk is higher, if investors are risk averse and vice versa. Risk aversion amongst investors varies with age, i.e., older investors are more risk averse and, therefore, demand higher premium compared to the younger investors. This risk aversion increases if investors value current consumption more than future consumption and vice versa.

The difference is that government or sovereign default has much greater spillover effects on all entities that operate within its borders, thus creating business risks. We start with an assessment of sovereign ratings, a widely accessible and hotly contested, of government default risk and then move on to market-based measures of this risk in the form of sovereign default spreads. It is at a record low when the risk-free rate used is the Indian government bond yield. Part of the reason for this is that Indian bond markets equity risk premium india have priced in monetary policy normalization very early, with the gap between the RBI-set repo rate and the bond yield at 235 basis points—record highs. At the same time, corporate earnings are emerging from a nearly decade-long earnings lull, and markets are confident of strong prospects for equities. This is one of the reasons we turned cautious on the market in September, and while the correction since then has moderated P/E ratios, we expect some time correction for the headline indices going forward too.

Equity Risk Premium in India: Comparative Estimates from Historical Returns, Dividend and Earnings Models

While we are much more constructive than consensus on India’s economy in FY23 and beyond, we have been concerned about valuations since September. Even if the Nifty remains unchanged for a year, and earnings estimates remain unchanged, the roll-forward impact on one-year forward earnings will only bring the P/E multiple to 18—the level at which Nifty had traded for four years pre-covid. However, we do expect upgrades to FY24 earnings—a year later that is what the market will be trading on, which should give some room for upside for the headline indices. The premium needs to be re-assessed periodically with changes in market performance and expectations of the overall economy.

This yield differs from the coupons on a bond in that returns on equity are not guaranteed (or capped) as they are on a coupon bond. In evaluating the impact on IIP, monthly IIP is regressed on previous six months change in ERP and similarly, quarterly GDP on previous two quarters change in ERP (Chart 7). Lagged values of both IIP and GDP are included in regression to gauge the predictive power of ERP over and above the past values of independent variables (GDP and IIP). Lagged terms are identified based on improvement to the overall fit of the model. Another common method that uses present data is to use the earnings yield which is the inverse of the PE ratio. For three decades, China has won this battle, but in 2023, the battleground seems to be shifting in favor of India, but it is still too early to make a judgment on whether this is a long term change, or just a hiccup.

Equity Risk Premium in India

Within the market, there are several sectors and stocks which are not as expensive, which can give good returns. It is time to bring back the car-driving parallels—stepping off https://1investing.in/ the accelerator is different from applying brakes. If monetary policy normalization is in response to stronger-than-expected growth, it should not affect capex and earnings.

Equity risk premium refers to an excess return that investing in the stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk of equity investing. The size of the premium varies and depends on the level of risk in a particular portfolio. This method relies on the principle that risk in both the equity and bond markets usually increases together and hence if we know the bond risk premium we can attempt to estimate the equity risk premium. So now what you do is that you take the current price of the index as the intrinsic price of the index. Now, all that you do is solve for the cost of equity and hence you end up with the equity risk premium.

What Is Equity Risk Premium, and How Do You Calculate It?

We have compiled the study after analysing public filings for 930 completed transactions from FY2017 to FY2023. The results are summarised by the class of intangible, size of the transaction, rate of occurrence of intangibles within the industry, contingent consideration, select key transactions and useful life of the intangibles. We can debate how best to measure operating risk exposure, since it can come from both where you sell your products and services (revenues) as well as where you produce those products and services. Conversely, the regions (Africa, large portions of Asia and Latin America) that are least democratic, with the most violence and corruption, have the most porous legal systems.

Equity prices contain information about both current and future economic conditions. Transmission of monetary policy actions to the broader economy takes place through various channels, including asset price channel, which leads to change in market value of equities and other securities. The advantage of default spreads is that they provide an observable measure of risk that can be easily incorporated into discount rates or financial analysis. The disadvantage is that they are focused on just default risk, and do not explicitly factor in the other risks that we enumerated in the last section.

The Cross Section of Expected Stock Returns

ERP is an indicator of uncertainty and is dependent upon various factors, such as, investors’ risk preferences, macro-economic fundamentals, savings rate, market liquidity, political stability, government policies, monetary policy, etc. Financial variables provide useful information in assessing economic conditions and consequently serve as an important input in monetary policy making. Further, monetary policy transmission also takes place through financial channel, which eventually influences the real sector. The immediate impact of monetary policy actions is mirrored in the prices and returns of financial assets, which is transmitted to broader economy through resultant actions of economic agents including households and firms. Unlike other lagging macroeconomic indicators including GDP and inflation, these variables are available on continuous basis and are also not subject to revisions, and hence can be used for real-time monitoring of macroeconomic conditions. My advice to you when you make a currency choice for your analysis is that you pick a currency that you are comfortable working with, but then make sure that you stay consistent with that currency in all of your estimates.

Economists argue that too much focus on specific cases has made a statistical peculiarity seem like an economic law. Several stock exchanges have gone bust over the years, so a focus on the historically exceptional U.S. market may distort the picture. Investing in the stock market comes with certain risks, but it also has the potential for big rewards. So, as a rule, investors are compensated with higher premiums when they invest in the stock market.