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Why India is a 'rally'ing point for the FIIs

V V L N Sastry in Bombay

The foreign institutional investors' investment in the Indian stock markets rose from Rs 134 million on June 4 to Rs 937 million on June 10, triggering a rally. The cause of the sharp rise has been traced to the recent spurt in Dow Jones Industrial Average of the United States. Indian core sector stocks, being part of the global trends, have been leading the rally in Indian stock markets.

The Dow's rise attracted the attention of global markets. The stock markets in emerging economies like India started dancing to the Dow's tune. The Indian stocks, in fact, began following the Dow's movements even in the pre-Kargil phase.

The Dow Index soared beyond the 10,000 level and sustained itself at that level, following the US economy's turnaround. The American economy has been showing healthy signals like low employment rates. The recent interest rate hike effected by the Federal Reserve has been factored in by the markets there as a temporary phenomenon.

This encouraged the US markets to go bullish on commodity stocks. This in turn raked in enormous profits for international funds. Flush with cash, the international funds decided in favour of partial allocations for the emerging markets.

Thus, some Rs 17 billion have been allocated to India since May, which has taken the Indian markets to fresh highs in the recent past. Like in the US, the commodity stocks led by the cement sector gained the most in India.

Managers of funds earmarked for emerging markets by FIIs attribute the upswing in core sector stocks to the general recovery of the economy. They cite the rising cement prices as a sign of economic recovery at large.

However, others say cement prices are rising because many states have stepped up implementation of infrastructure projects on the eve of elections. So the demand for cement is temporary, they say.

There is no governmental support for the infrastructure sector. However, the core sector has been getting and will continue to get financial support from international institutions.

However, opinions differ over the issue. Production figures of steel, cement, textiles show no major improvement in 1998-99. The macro economic figures and projections by world bodies indicate no change in India's economic fundamentals. The markets have been moving without any sectoral focus.

There has been no change in economic outlook or re-rating of India's creditworthiness. Nor have the core sector corporates in India suddenly started performing well. Then what explains the sudden liking that the FIIs have taken to India?

A look at the macro-economic outlook is necessary here. Short-term interest rates in India are likely to continue at current levels or come down a little. In the absence of any core sector credit offtake, even long-term interest rates are unlikely to change a lot.

The financial institutions are not willing to refinance the existing non-performing or badly performing core sector projects. So the long-term interest rates may continue at the current levels. In the absence of good projects and performing assets, how the banking sector will maintain the current levels of earnings remains to be seen.

In the absence of any further credit, the partially executed core sector projects will have to bear the burden of interest payments. And this at a time when their products are not fully out yet and when the demand for them shows signs of remaining stagnant for the next 24 months.

On the foreign exchange front, the rupee is expected to hover around the Rs 43 to US $ level for the next six months at least. For no major policy changes are expected because the Union government is a caretaker one.

The International Monetary Fund's outlook for India is negative on account of current account deficit. Fiscal deficit that is under considerable strain is another problem area.

A study of gross private flows to emerging markets throws up a different perspective. Asia got $ 10 billion in the first quarter of 1999-20000 ($ 34 billion in 1998-99). Europe got $ 3.10 billion ($36.1 billion), the Middle East and Africa got $ 3.30 billion ($ 14 billion) and Western Hemisphere $ 12.1 billion ($ 64.6 billion).

The net capital flows to Asia have been negative in 1998-99, as against the positive flows in the three previous fiscals.

It is well known that the cement sector cannot perform well in the absence of growth in the infrastructure sector. Ditto for steel. Tourism is on the wane so it is unlikely that the hotel industry would witness a boom in the near future.

Yet, these sector specific stocks fared very well in the recent past. The inference one can draw is that FIIs invested in India not because of what they profess (fundamentals are strong and all that) but because they had surplus funds that needed to be invested outside the US. And Indian core sector stocks were found relatively cheap and hence were picked up.

Whether the rally would sustain itself in the absence of continuous support from FIIs remains to be seen.

The writer is vice-president, equity research and investment banking, Khandwala Securities, Bombay

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