Foreign investors return with high hopes for India vote

Just seven months ago, investors shunned the Indian markets because of growing concerns about the economy. The rupee hit a record low. Stocks plummeted.

Now, investors are back in anticipation of a more business-friendly government's winning the national elections in April and May. India's two benchmark stock indexes, the Sensex and the Nifty, have been rallying to new highs, defying the weakness in other major emerging markets. The rupee is up more than 14 percent from its low last year.

Foreign investors are playing a big role. As the outcome of the elections has become clearer, foreign investors plowed more than $2 billion into Indian stocks in February and March, a reversal from the start of 2014.

But investors may be overly optimistic, analysts say. India's economy still faces challenges, and the underlying structural problems will not be easy to fix.

Largely, investors are betting that the opposition Bharatiya Janata Party will replace the current government, led by the Indian National Congress, and Narendra Modi, chief minister of Gujarat, will be named prime minister. Modi is known for welcoming foreign investment in his home state, making him something of an outlier in a country where it can be difficult to do business.

"Expectations are very high that Modi will lead the new government in India, and investors are viewing that as quite a game-changing event for India going forward because of his economic track record in Gujarat," said Sam Mahtani, a director of emerging market equities at F&C Investments in London, which invests $3.3 billion in those markets, about 10 percent of it in India.

"He is viewed as a very pro-reform leader, and that is effectively what the market is anticipating and wants," Mahtani said.

He cautioned that investors had bet on the wrong party and candidate before. ''I have personally tracked elections across emerging markets for the last 20 years, and ultimately they are unpredictable,'' Mahtani said. Despite the opinion polls, "there is still a level of uncertainty.''

In 2004, the Congress-led coalition government came to power, although most polls suggested that the Bharatiya Janata Party would win. After that, the markets dropped 18 percent.

"Even if Mr. Modi is to come to power, nothing is going to happen overnight," said Rahul Arora, chief executive for institutional equities at Nirmal Bang Securities, a brokerage based in Mumbai. "Economic recovery is going to be a slow process."

Arora added: "Currently, the valuations are a function of an expectation for change. Towards the back end of this year, the valuation will be a function of the fundamentals. I think if the recovery is not there fundamentally on the ground, then you run the risk of a fund outflow."

Investors started to rethink their stance on India late last year. Since then, the Bharatiya Janata Party performed well in four state elections and the stock market made steady gains.

Buoyed by the expectation of change, foreign institutional investors poured about $6 billion into Indian equities in the quarter that ended in December, according to a report this month by Bank of America Merrill Lynch analysts. That compared with $700 million in the previous quarter. Foreign institutions' holdings in Sensex member companies were at an eight-year high.

The economic environment also has improved modestly.

The government imposed duties on gold imports to try to cut the trade deficit. In an effort to rein in inflation, the central bank has raised interest rates three times since September. The government has also approved several important infrastructure projects that had been stalled by bureaucratic bottlenecks.

On March 18, Goldman Sachs upgraded Indian stocks to overweight, from market weight.

Indian markets are also benefiting from the struggles of emerging countries like China, where slowing growth worries investors, and Russia, where stock markets have been rattled by political tensions in Ukraine. Turkey and Brazil have been hurt by concerns that growth will slow as the Federal Reserve pares its stimulus campaign.

"The alternatives across emerging markets are not necessarily very attractive," said Herald van der Linde, head of Asia-Pacific equity strategy at HSBC. "And that explains why the portfolio of mutual fund holdings across the region shows that people are underweight on emerging markets but are overweight on India."

The question is: How long will the optimism last?

Ajay Bodke, head of investment strategy and advisory at Prabhudas Lilladher, a Mumbai brokerage firm, warned that this "rally of hope" in India could easily dissipate once investors see who actually wins the elections.

"There's a lot riding on what kind of government comes to power in Delhi," he said.

© 2013, The New York Times News Service