Few of the world’s stock markets have offered a haven from fears of a double-dip recession and Europe’s debt crisis. India, though, is one. Investors have sought sanctuary in its growth prospects and capital inflows have surged. The question now is whether Indian equities are overpriced.
Those who bet on a strong performance from India’s stock market this year have been rewarded. Indian equities have outperformed all their main rivals. The Sensex, India’s benchmark index, which hit a 31-month high on Monday at 18,560.05, has risen 6.27 per cent since January 1. The Shanghai Composite in China, by contrast, has dropped 17.7 per cent and Brazil’s Bovespa index has fallen 4.81 per cent.
Asia’s third-largest economy has offered an attractive combination of economic stability and almost double-digit growth for fund managers anxious about US and European fragility. Net total foreign investments in Indian equities to August 31 were Rs594bn ($12.7bn), up from Rs403bn during the same period in 2009, according to the country’s market regulator.
Foreign investors also bought a net Rs389bn of bonds from the start of the year to July 30, compared with a year earlier when investors sold a net Rs37.2bn in bonds in the same period – a sign that investors’ confidence in the government’s ability to rein in its ballooning public debt has increased. Many analysts expect foreign capital inflows in the equity market to overtake the record Rs17bn in 2007.
KN Sivasubramanian, head of Franklin Templeton’s India Equity portfolio management, says: “India is a largely domestic-driven economy and recent economic and earnings data has been encouraging. Overall, we are seeing both domestic and global investors recognise the [Indian] growth potential.”
Cameron Brandt, senior global markets analyst at EPFR, says: “There was a fair amount of attention being paid to the deterioration of India’s public finances and the risk that, when combined with food and energy-driven inflationary pressures, the central bank would be forced to tighten aggressively. That hasn’t really happened.
“Meanwhile, the nervousness about the strength of the recovery in the US, Europe and Japan has cast a favourable light on the strong domestic component of India’s story.”
But for investors the problem is that a lot of the good news is now in the price. Indian equities trade at more than 17 times forecast earnings for 2010, compared with a five year average of 16.2 times earnings. By comparison, emerging market equities in general trade on an average of 12 times 2010 earnings, while Russia trades at just 6.7 times forecast earnings. That is a hefty premium.
Philip Poole, global head of macro and investment strategy at HSBC global asset management says that, while there is a lot of momentum in the Indian market, he has India as an underweight mostly due to valuations. “Relative to past trading history, the Indian equity market looks fully priced. Within an emerging markets context it looks toppish.”
While India has potential, it also has risks. Indeed, inflation is running at the highest level in any leading emerging market – with nearly 11 per cent forecast for 2010, compared with about 3 per cent for China, 4.9 per cent for Brazil and 7 per cent for Latin America.
Indian economic policymakers have made big strides in recent years in developing consistency. But they have yet to establish the same long-term sustainable growth records as their counterparts in some other emerging markets, notably China and Brazil. “Indian growth is very strong, but that leads to inflation pressures. The authorities will need to act to slow the economy,” says Mr Poole.
“Inflation is a real concern and we expect yields for the [benchmark] 10-year bonds to come under pressure, as the Reserve Bank of India tightens the monetary policy,” says A Prasanna at ICICI Securities.
“India is certainly a longer-term story. Promised reforms and the efforts to boost rural incomes and productivity are not going to happen overnight,” says Mr Brandt. “There are more attractive destinations for ‘hot’ money at the moment.”
Duvvuri Subbarao, the governor of the RBI, told the Financial Times in July that growing risk aversion among foreign investors could have a negative impact on capital flows to India. “Such a slowdown in capital inflows will constrain domestic investment, which is critical to achieving and sustaining high growth rates,” he said.
Nevertheless, the fundamentals behind India’s growth story – abundant liquidity and strong domestic demand – are unlikely to disappear anytime soon, according to Rohit Kapur, at KPMG. “There is a lot of money on the sidelines ready to be invested in India ... people are here to stay and get what they can’t elsewhere: high returns.”
V Jayasankar, executive director at Kotak Investment Banking, says the private equity sector is likely to be a big player driving more money into the markets. “There are various estimates that show that about $25bn to $30bn are waiting to be invested in India by global private equity funds.”
As one veteran investor puts it: “Some bad news would be good news so that we can start getting back into the game.”
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