×

Darling of EMs about to get more love

Punit Paranjpe | AFP | Getty Images

Indian stocks stole the show this year as decisive leader Narendra Modi won investors' confidence, but will the love continue into the New Year?

Global emerging market investors' exposure to India is well above historical levels, according to a Bank of America Merrill Lynch fund manager survey released this week. Exposure to India is now around three standard deviations above the mean relative to its history. By this measure, it's currently the most-loved market for both emerging market and Asia-Pacific investors.

Fervent buying by overseas investors helped drive a breathtaking 32 percent year-to-date surge in India equities, leaving emerging market peers in the dust. China stocks, by comparison, have risen 15 percent, while Brazil equities gained just 3.7 percent.

"There's a lot of money flowing into Indian equities… the foreigner is still dominant, but the domestic investor is beginning to count," Citi wrote in a note titled 'Owning India Inc: High Tide.'

Read MoreModi, Ma debut on Forbes 'most powerful' list

Foreign investors have pumped over $15 billion into the equity market so far this year, according to Citi.

Full speed ahead

"Rising flows suggest investors are not taking chances: they are investing, not waiting to invest. While we do believe there will be small swells and ebbs, the inflow tide should stay strong for a while," Citi said.

The bank forecasts the benchmark Sensex index will rise to 31,000 by end-2015, 10 percent from current levels.

The index is already trading near all-time highs, last seen at the 28,032 level.

Capital Economics agrees Indian stocks will continue to outperform over the longer term.

Read MoreCrackdown on 'black money' takes off in India

"The rally has come amid signs that Prime Minister Modi is now more willing to push through politically difficult structural reform following the BJP's (Bharatiya Janata Party) decisive victories in two key state elections last month," said Shilan Shah, India economist at Capital Economics.

Capital Economics sees the index rising to 30,000 by end-2015 and 33,000 by end-2016.

Strong fundamentals

In addition to reform momentum, economic fundamentals are falling into place as growth bottoms and inflation eases.

Consumer prices rose a slower-than-expected 5.5 percent on year in October, following a 6.5 percent increase in the previous month, led by a fall in local food prices. This was the slowest pace since the index was launched in January 2012.

This trend is expected to continue. "The potential drivers of declining inflation are: lower food inflation, due to better policy and an improving monsoon, plus lower transportation fuel inflation," said JP Morgan, which has an overweight recommendation on Indian equities.

Read MoreIndia data builds case for rate cut before Christmas

While growth is below trend, this is expected to improve with rising business confidence, the bank said.

Asia's third largest economy grew 5.7 percent on year during the April-June period, its fastest pace in over two years, up from 4.6 percent in the previous three months.