Is foreign interest in India peaking?

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Overseas institutional investors have pumped billions of dollars into Indian equities over the past year, fueling a seemingly unstoppable rally, but signs suggest that foreign interest may be peaking, according to analysts.

"Our interactions with 80 investors in the USA suggest FIIs' (foreign institutional investors) incremental interest in India is near a short-term peak," Mahesh Nandurkar, India equity strategist at CLSA wrote in a report published on Tuesday.

There is growing unease about weak corporate earnings, says Nandurkar, which will unlikely see a meaningful recovery for a couple more quarters.

Furthermore, big-bang reforms including the passage of the land acquisition bill and goods and services tax (GST) bill appear to be some time away, he said.

"While there is a general agreement on the attractiveness of India's structural long-term story, several investors appeared to be seriously re-evaluating their positioning and incremental inflows seem unlikely in the near term," Nandurkar said, adding that the risk of a near-term pull-back in the market is rising.

After scaling fresh highs earlier this month, the rally in the benchmark Sensex stalled in recent weeks amid concerns about a lack of catalysts. The index is down 4 percent so far this month, but remains up 2.5 percent year to date.

"With a good budget and two surprise rate cuts now behind us, the only macro triggers to look forward to in the near term are potential passage of the land bill and visible progress on the GST bill," said Nandurkar.

Earnings in focus

Sanjeev Prasad, senior executive director and co-head of Kotak Institutional Equities has also noticed a growing concern among investors, particularly around the weak earnings trend.

In the October-December quarter, earnings of India's largest companies failed to meet expectations. The combined net income of 100 firms with a market valuation of more than $100 million dropped 6 percent in the quarter from a year earlier, according to Reuters. That compares with a 0.5 percent rise forecast by analysts covering the companies.

"Investors are questioning how quickly the country's macro improvement will translate into better earnings," Prasad told CNBC.

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"Sectors such as auto, banking, industrials, oil and gas, metals and mining face the risk of cuts to earnings estimates. Assumptions have been too high and the investment cycle has not picked up as expected," he said.

Prasad, however, isn't worried about a correction in markets just yet.

"Global liquidity is strong and India still stands out in the emerging markets sphere in terms of growth and a stable macro environment, compared with Brazil and Russia, for example. Even if there is a pull-back, it will be limited," he said.

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Prasad says he's more apprehensive about what happens to the market two quarters down the line.

"If by then we still don't see an earnings improvement, and we see the U.S. raising rates and oil prices moving up, then I would be quite worried," he said.

The big picture

While some investors are growing uneasy, others have adopted a more patient approach.

"We agree with the [long-term] positive structural story, so would consider any pull-back as a buying opportunity," said Simon Grose-Hodge, head of investment advisory, South Asia at LGT Bank.

"We wouldn't expect that pull-back to be too aggressive, unless the Federal Reserve suddenly becomes a lot more hawkish, which we don't expect."