Capital cost may rise as drivers of equities reverse: Report

Three decades have been benign for global equities, but that time is now changing

Some key drivers of global equities for 30 years are likely to reverse in the next decade, potentially queering the pitch for equity investments.

Geopolitical risks, higher interest rates, China’s slowdown, and higher environment-related costs are likely to drive up the cost of capital, according to a report by Kotak Institutional Equities (KIE).

The report said the past three decades have been benign for global equities, as it was a period of calm after the fall of the Soviet Union in the early nineties. Now, there is a risk of geopolitical tension due to the increasing competition between China and the United States for global dominance. China and Russia want to reverse the alleged wrongs by the US and the West in the past few decades and colonial and imperial powers before that. The Ukraine war is the fallout of this thinking. Separately, the emergence of medium-sized economic and military powers with different agendas and ideologies increases the chances of geopolitical tensions.

A sharp increase in inflation in the past 12-18 months may have pulled central banks away from their policy of low or negative real interest rates to drive economic growth. They are likely to follow a more conventional monetary policy. Governments will now rely more on fiscal policy to support growth in crises. However, higher fiscal deficits will lead to higher government bond yields and interest rates.

The slowdown in China and other emerging markets' inability to take its place will affect global gross domestic product (GDP), said the KIE report.

China accounted for 24 per cent of global growth in 1991-2021, as it ‘exported’ disinflation to the rest of the world through a massive reduction in the cost of production of most manufactured items. Moreover, its excess savings could support large deficits and suppress interest rates elsewhere.

Companies will have to deal with their business models being disrupted by climate change and find technological solutions, the report said. Companies and customers would have to contend with the higher cost of de-carbonization. This will mean uncertainty to business models and higher costs.