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Stock Markets Cheer India Reforms, but Can Gains Last?

Indian stocks are getting a boost after the government stunned markets last week with a slew of aggressive steps to revive the economy. But India watchers warn that the rally could be short-lived, unless Prime Minister Manmohan Singh shows resolve and follow through with the unpopular measures.

India Traders
AP
India Traders

India’s Sensex 30 Index rose 2 percent on Monday to a 14-month high, extending the 2.5 percent gain in Friday, after the government said it was opening up the retail sector to foreign supermarket chains and removing the bar on foreign investment in both airlines and broadcasters. It also approved the sale of stakes in four state-run industries and cut fuel subsidies.

The news will definitely improve investor sentiment, said A.S. Thiyaga Rajan, Managing Director of Aquarius Investment Advisors in Singapore, and drive money into into retail and consumer staples sectors, as well as aviation, pharmaceuticals and manufacturing. But the question remains if the gains can be sustained, he added.

“I think definitely everybody is surprised by it (the announcements),” Rajan told CNBC. “The market moved up substantially on Friday and the continuation of these reforms is very important or it is not going to go anywhere. Hot money will go in and come out. But it’s a good start.”

If investors see that the government can “stand their ground” in the face of opposition and push through with reforms, Rajan believes the Sensex can jump to 19,000, or 10 percent from current levels, in the next month.

The Indian stock market has been one of the best performing this year, having gained close to 21 percent this year, thanks to a weak rupee and foreign capital inflows. A new pro-reform Finance Minister Palaniappan Chidambaram, who assumed office in July, also provided a short-term boost to investor sentiment.

Managing Director of Bowen Asia Aadil Ebrahim, whose firm owns retail stocks in India, said the measures would not only directly benefit retail and airlines stocks but also boost the broader market.

“This is a very aggressive move by the administration but necessary steps to revive investor confidence,” Ebrahim said. “There will be serious obstacles but the government is now prepared to fight it out in their corner and we are happy that they have chosen to go down this route.”

While cheering the reforms, some strategists warn against being too bullish, too soon. Nicholas Ferres, Director of Global Asset Allocation at Eastspring Investments, said he recently scaled back on Indian stocks because they are not cheap, and, inflation—running at 7.55 percent— is still a problem. In addition, corporate profits could take a hit going forward because of the removal of fuel subsidies.

“The rhetoric on investment is encouraging, but private investment still faces weak domestic and external demand, high energy prices, inflation and cost-of-capital. Indian companies still have better profitability than most, but returns on capital are falling in trend terms,” he said, adding that investors will remain skeptical.

“After all, the current government's record has been truly appalling,” he said, referring to policy flip-flops including a reversal of the retail-sector reforms earlier in the year.

By CNBC’s Jean Chua.