India's high average cost of equity indicates perceived risk in economy: report

The average cost of equity, an indicator of return required for investors, is higher at around 15% compared to developed countries, says a report.

Consultancy EY said the cost of equity has remained constant even as interest rates declined over a period of time.

Generally, cost of equity is referred to as the return that is required for an investor to make an investment.

"The average cost of equity in India is around 15%. The cost of equity has remained constant since the previous cost of capital survey undertaken by EY in 2014, over a period in which interest rates have declined by 200 basis points," it said in a release.

The findings are based on the Cost of Capital Survey that covered 135 individuals, including chief financial officers.

"The stagnancy in cost of equity despite falling interest rates is indicative of a perceived increase in the risk in the economy, leading to companies expecting a higher premium for equity investments," EY said.

Overall, average differential in the cost of capital for investing in India versus other developed countries is around 4% in dollar terms, it noted.

The conclusion is based on responses from participants on the difference in discount rate for investing in India compared to developed countries. The discount rate is generally termed as cost of equity.

As per the survey, the cost of equity is highest in sectors such as real estate and EPC while FMCG and capital goods enjoy the lowest cost of equity.

Noting that the cost of equity across sectors appears to have converged, EY said this trend again "implies a larger impact of political, regulatory and macroeconomic factors on overall business risks with lesser impact of sector specific risks".

EY Partner and Leader Valuations and Business Modelling Navin Vohra said the cost of capital is an important variable in capital budgeting and M&A decisions.