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Enthusiasm for Indian Stocks Intact Despite Poor Growth

India’s gross domestic product (GDP) report is due out Friday and economists are not expecting any dramatic turnaround in Asia’s third largest economy. The consensus is that growth in the April to June quarter was likely a repeat of the previous quarter’s lackluster 5.3 percent - but investors are shrugging it off.

People wave Indian national flags during a ceremony to celebrate India's 63rd Republic Day at the India-Pakistan Wagah border post on January 26, 2012. India celebrated its 63rd Republic Day with a military parade in several towns across the country.
Narinder Nanu | AFP | Getty Images
People wave Indian national flags during a ceremony to celebrate India's 63rd Republic Day at the India-Pakistan Wagah border post on January 26, 2012. India celebrated its 63rd Republic Day with a military parade in several towns across the country.

The country’s equity market has seen a surge in inflows this year making the benchmark Bombay Sensex, which has risen over 13 percent year-to-date, one of the best performing indices in Asia.

Bad news out of India this year ranges from a threat of a credit ratings downgrade - driven by mounting fiscal deficit and a lack of any policy response to slowing growth - to the most recent power crisis which impacted half the country’s 1.2 billion population. Despite this, investors have continued betting on India.

Since the start of 2012, foreign institutional investors (FIIs) have pumped almost $12 billion into the stock market – the highest inflows among Asian, ex-Japan, markets so far this year, according to HSBC. This compares to a net outflow of $358 million last year.

“The talk or rhetoric on India is much more negative than investor positioning - this has been somewhat surprising given the multiple problems India is facing,” Rajeev Malik, Senior Economist at brokerage CLSA told CNBC.

“(But) there is a perception among some FIIs that compared with many other economies, the Indian situation is relatively less bad. Plus there is a long term story here even though the shine has come off and the current policy paralysis remains a stumbling block,” he added.

Liquidity Driven Rally?

While the turnaround in the Indian market – which slumped 25 percent in 2011 – is partly linked to the rise in global liquidity, Mumbai-based Jitendra Sriram, Director and Head of Research at HSBC, says investors have been lured to the country because of its strong domestic focus, which shields it somewhat from the slump in Europe and the United States unlike many other Asian countries.

“India has limited external linkages. With fears on U.S. & EU, money has preferred to flow into more domestic economy oriented themes,” Sriram said.

Within the BRIC (Brazil, Russia, India and China) space, he adds investors are viewing the Indian economy as “counter-cyclical.”

“Investors who have been concerned about the China slowdown and the impact it could have on resource heavy economies like Brazil and Russia, believe that a weaker China growth could alleviate price pressure on commodities which in turn could be positive for India - a big importer of energy,” Sriram said.

Lower commodity prices, which help ease inflationary pressures in India, could provide an opportunity for the central bank to ease monetary conditions.

Stability in corporate earnings alongside attractive valuations has also played a key role in attracting funds into the market. The Sensex is currently trading at a price-to-earnings ratio of 13.3 times, compared to a historical average of 15-16 times.

Nicholas Ferres, Investment Director at Eastspring Investments, who became overweight on the country’s stocks in June for the first time in five years, says his decision was based on the market’s low valuation relative to its own history.

In addition to institutional investors increasing their exposure to the Indian market, there has also been a pick-up in interest from sovereign wealth funds, particularly from the Middle East, according to Sriram.

Sriram, who has a year-end target of 18,700 for the benchmark index – which marks a 7 percent upside from current levels, says positive momentum for equities will hinge on government action to improve the investment climate, efforts to improve the fiscal deficit and the outlook for agricultural growth in the light of a deficient monsoon.

Investors will be watching the month-long parliament session ending on September 7 for signs of progress on economic reforms.

CNBC's Gauri Bhatia also contributed to the report

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