With just two days to go for Budget 2024, Chris Wood on what's making Dalal Street nervous

Despite a strong rally in recent years, the Indian stock market is still in its infancy when it comes to developing a robust equity culture, according to Christopher Wood, Global Head of Equity Strategy at Jefferies. As the Budget 2024 announcement on July 23 approaches, any changes to the capital gains tax on equities could trigger a significant market correction, potentially larger than the one seen after the Lok Sabha election outcome on June 4, where the BJP lost its majority but formed a government with coalition partners.

Wood's confidence in the Indian stock market's future is rooted in the increasing participation of retail investors, particularly in mutual funds. This trend, he believes, will continue to bolster the market. Despite the BJP's election setback, the stock market rebounded quickly, up 13.3% since June 4. This swift recovery highlights the growing influence of retail investors who have continued to buy as professionals sell.

The ownership landscape of Indian stocks is shifting. Retail investors and mutual funds have increased their share from 16.6% at the end of FY21 to 18.4% by the end of FY24. Conversely, Foreign Institutional Investor (FII) ownership has declined from 22.1% to 19.9% over the same period. This shift underscores the domestic-driven nature of the market, which Wood describes as still in the early stages of a burgeoning equity culture.

Indian stock market capitalization has soared to $5.2 trillion, a 296% increase from its low of $1.3 trillion in March 2020. It now represents 1.96% of the MSCI AC World Index, up from 0.93% in March 2020. Although market capitalization is now 145% of GDP, up from 52% in March 2020, Wood argues this isn't a reason to sell, except for short-term tactical moves. His global long-only equity portfolio still has a 26% weighting in India, indicating strong confidence in its long-term prospects.

Wood advises keeping a close eye on the Budget 2024 for signs of populist measures to satisfy coalition partners. While there is less concern about a potential increase in the capital gains tax rate, any significant hike could trigger a larger market correction than anticipated. The budget is expected to address the demands of minority parties, but the extent of populist measures may be limited due to the government's reduced mandate.

Another factor bolstering confidence in the Indian market is the growing belief in the rupee's long-term stability. A stable or appreciating rupee would enhance the attractiveness of Indian equities, which are primarily driven by domestic demand. This domestic focus, coupled with increasing retail participation and stable currency expectations, forms a compelling argument for the sustained growth of India's stock market.