Events And Issues

New Delhi, 12 July 2007

India’s Capital Market

WILL THE BULL RUN SUSTAIN?

By Dhurjati Mukherjee

The capital market has been surging ahead with the inflow of global funds on an unprecedented scale. From 7000 on 20 June 2005, the sensex crossed the 8000 mark on 8 September 8 and the 9000 mark on 28 November. Last year it crossed the 10,000 mark on 6 February, the 13,000 mark on 30 October ending the year at 13800.

This year after a dull start, the sensex crossed the 15,000 mark on 6 July and analysts are optimistic the positive trend will continue, with the March 2008 target put at 16,000-17,000. The confidence stems from the fact that India is the second fastest growing economy in Asia (and possibly one of the fastest in the world) and the current valuations of the equity market still appear lucrative to investors.   

The Indian story of spectacular performance during the last 4 years is viewed with interest by the world’s financial capitals and analysts are unanimous that the growth is “sustainable and secular”. India’s growth story has become globally acceptable, following big acquisitions by Indian entrepreneurs who have proved that they can manage businesses beyond the country’s boundaries. Experts point out that though China remained an important FDI destination, India too was becoming an integral part of global portfolio investments.

The market surge over the last two years has been fuelled by better-than expected monsoon rains, excellent economic growth (current year pegged at around 9 per cent) and outstanding corporate performance. Both the GDP and market capitalization are around $1 trillion. Economists feel that a higher ratio of market capitalization to the GDP reflects economic maturity. In developed countries, this ratio is always in excess of one, while in developing countries it is below 0.5. For instance, in the UK it is 2.5, which means the market cap is 2.5 times the GDP, 1.8 in the US and 0.3 in China.

Interestingly, the bull run since early 2005 is different from the ones in 1991 and 1999. It is not one big rush but a sustained push by optimistic investors. India is widely viewed as one of the best and safest of the emerging markets, which will give attractive returns resulting in a steady buying momentum by the FIIs. Moreover, with SEBI introducing a number of disclosures, the stock market has become more transparent and attractive.

Several research reports have indicated that though the earnings growth momentum will be sustained it may come under pressure due to the oil price hike. However, the FMCG segment, construction, power equipment, capital goods companies and IT scrips etc have recorded remarkable gains in the last few months.

An ICICI Securities report has predicted that IT stocks could reach new highs in the current financial year. A 30% growth due to increased spending and revenues from new service lines – BPO and enterprise solutions (business intelligence and data warehousing). The NCAER, an independent think tank, has predicted that higher consumer demand and export order could drive industrial growth. This has been reiterated by the Reserve Bank of India and the Finance Ministry. Some feel that due to a paradigm shift in the country’s policies and the economy gaining strength has led to buoyancy in the stock market.

A Citigroup report ‘Earnings Outlook – Deceleration Ahead’,  pointed out: “One of the key factors behind the spectacular re-rating of the Indian equity market has been strong earnings growth, which averaged over 26 per cent for the last four years up to financial year 2005.” It prediction that while double-digit growth would continue, “our bottom-up forecast suggest a significant deceleration over the next 12 to 18 months” has been proved wrong.  

The boom in equities has been fuelled by huge inflows of funds from overseas investors and FIIs. The momentum of FII investment in India can be gauged from the number of new FIIs being registered. There are presently around 975-980 FIIs registered in the country, according to the SEBI data. The overseas investors pumped in a record $ 10.7 billion in 2005 and a little over $ 8 billion in 2006. In fact, India was the second biggest recipient of offshore funds in Asia in 2005, next only to Taiwan’s $ 12 billion.

According to the Institute of International Finance, the inflows are expected to fall by $ 1 billion this year. This does not augur well for the market, which has been rallying on the back of ample liquidity. Any diversion of the existing FII portfolio upwards of $ 125 could compound the problem. 

Moreover, as per the guidelines of the RBI, the FIIs can invest up to 24 per cent of the paid-up capital of an Indian company and 20 per cent of the paid-up capital in case of public sector banks. The FII investment in the stocks of the blue chip companies have already been reached. Leading to waning of interest by the domestic players as well. The FIIs focus on mid-cap stocks has resulted in significant bull activity. Many companies are passing special resolutions to hike the ceiling for FII investment to attract more fund flows and impress investors. 

The strong fundamentals and the pro-industry attitude of the Government has kept the sentiment of the market almost unhindered but the same enthusiasm may not manifest this year. According to ASSOCHAM, the Government could have raised Rs 31,000 crores in the current stock market boom by divesting only 10 per cent of its stake in the top 14 public sector undertakings. But pressure from the Left parties has not made this possible. Only time will tell whether the Government yields to the Left pressure or convinces them to support partial disinvestments of some PSUs.

The interest in the capital market has affected even small savings. In Maharashtra and West Bengal, accounting for more than one-fourth of the country’s net small savings collections, there has been insignificant growth rate in 2004-05 onwards. The trend is more or less the same in most other states. The high returns from the equity market and mutual funds have inspired investors to shy away from postal savings/banks and invest in stocks.

The sustained inflow into local stocks from overseas funds has kept the rupee steady. It is now trading at Rs 40-Rs 41 due to cushioning by strong foreign investment in stocks for most of the year. As most software companies earn huge revenues from exports, further strengthening of the rupee vis-à-vis the dollar may have an impact on their bottom line though oil companies may benefit.

The challenge of sustaining the market in the coming days at an overvalued level will be tougher and requires a sustained scale of flows, despite better corporate performance and the FII growing interest. But the hike in interest rates may affect the corporate sector, in terms of demand than on profits. For sensex companies, a 2 per cent increase in interest rates would chop off 3 per cent of earnings. 

Clearly, as long as the fundamentals of the economy remain strong, one can expect a reasonable continuous inflow of funds. True, India is possibly among the most expensive Asian markets but this is cushioned by the high real EPS and shift in domestic savings to equity. More. India is now the third largest emerging market in Asia after Korea and Taiwan.

For the market to keep the present momentum, it will be necessary for companies to keep up its growth plans to generate confidence and buoyancy. For an investor, the short-term rallies or the unexpected quarterly/half-yearly results of a company should not be the investment index but its long-term implications of growth. But they need to go with a systematic investment plan; as markets reward the patient investor. ----- INFA

(Copyright India News and Feature Alliance)