Foreign fund flows into India in 2010 could match or exceed a near-record $17 billion in 2009 but will not give the Mumbai stock market the same boost this year, as a flood of new share sales soak up cash and cap overall gains.
Initial offerings by the likes of Jindal Power or new shares sales by state-owned firms such as miner NMDC Ltd could be magnets for overseas investors, and would put further upward pressure on the Indian rupee .
The long-term case for investing in India, like China, is clear: a billion-plus population driving consumption-led growth. Analysts see 2010 fund inflows easily matching last year's.
Indian firms raised about $19 billion in new equity in 2009, and Morgan Stanley figures they could raise $70 billion over the next three years. Overseas investors tend to be the biggest buyers of fresh Indian equity.
"Within emerging markets, I would say there is no alternative to India and China," said Vinay Gairola, managing director and portfolio advisor in Mumbai with Atlantis Investment Advisors, a $2.9 billion London-based fund manager.
But India has had a tendency to underperform relative to its potential and to China, and its higher valuations may hamper the appeal.
Michiel van Voorst, who helps manage a 500 million-plus euro ($714 million) Asia-Pacific portfolio for Dutch fund manager Robeco in Hong Kong, said India valuations look steep in the context of its high interest rates and is underweight India relative to the MSCI Asia Pacific index.
"We do see the growth, but we also have a couple of risk factors that we keep in the back of our mind," said van Voorst, whose India weighting has been steady at about 4 to 5 percent.
"For us, the market has gone a long way into discounting the good outlook for India," he said, citing more favourable risk/reward cases in Thailand, Indonesia and Taiwan.
Morgan Stanley forecasts the SENSEX will reach 19,400 by December, up 10 percent from current levels. Its preferred sectors include lenders like State Bank of India (SBI.BO: Quote, Profile, Research), which will gain from rising interest rates, but it is avoiding tech firms, which will be squeezed by a rising rupee.
The performance of India's BSE index typically has a close correlation with foreign inflows as many overseas investors pick index stocks. That may change in 2010 as the flood of new equity draws funds away from blue chip companies and limits gains in the benchmark index, which jumped 81 percent last year.
For a graphic on foreign fund inflows and the performance of the benchmark, click on: r.reuters.com/kuc44h
Foreign inflows helped push the rupee up 4.7 percent in 2009, fuelling talk of government action to stem the flows, but few observers expect it to impose controls soon given India's need for money to build roads, power plants and other major projects.
RISKS AND OPPORTUNITIES
Based on MSCI indexes, the Indian market is already looking pricey relative to the broader Asian market. At 17.5, the one-year forward price-to-earnings ratio (P/E) is about 11 percent above its five-year average, according to data from Thomson Reuters I/B/E/S.
For the broader MSCI Asia-Pacific region excluding Japan, its P/E ratio of 14.8 is about 9 percent above its five-year average. The same ratio on the South Korea MSCI index is only a fraction above the five-year average.
For foreign investors, much depends on whether the government delivers on expected reforms, such as selldowns of holdings in state firms and speeding up work on badly needed infrastructure.
Last year's sweeping re-election of Prime Minister Manmohan Singh's Congress party government spurred high hopes for market-friendly reforms but they were delayed or derailed by the global economic slowdown and a summer drought.
"The government not delivering is a big risk, though I think the probability of that is pretty low. I think they know what needs to be done," said Suresh Mahadevan, head of India equity research at UBS, adding that improving economic indicators and corporate earnings will also attract foreign funds.
India has tended to lag the rest of the region because of its deep fiscal deficit, which on track to reach 6.8 percent of GDP in the current fiscal year, high interest rates, a sclerotic bureaucracy and political risk in a raucous democracy led by a party whose base of support is largely rural and poor.
Still, India is showing signs of returning to high growth after slowing to 6.7 percent economic expansion in the year that ended in March following three straight years of growing by 9 percent or more. Only China is growing faster.
Government stake sales in state firms could fetch $6.5-$11 billion in the fiscal year starting April 1, and foreign demand for new shares is likely to be strong, analysts estimated.
Overseas institutions, for example, bought $763 million in stock sold this month by Reliance Industries.
"Large issuances will definitely attract global money," because they allow foreign institutions to take big positions without driving up their cost of entry, said Alroy Lobo, chief strategist and global head of equities for the asset management arm of India's Kotak group.