Indian market most expensive, but FPIs may still love it: Here’s why

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NEW DELHI: On paper, the domestic equity market is the most expensive emerging market globally. Yet, hope of a sharp recovery in earnings has lifted stocks to all-time high levels.

For overseas investment flows to be strong in 2018, earnings need to meet the heightened expectations. They have been disappointing the Street in each of the past few financial years.

While PE is high for the Indian market compared with global equities, it is not expensive, brokerage CLSA suggested in a note.

There are early signs of earnings recovery, though at a modest pace.

“While the Q2 earnings season turned out to be one of the best in three years with no earnings cuts, we believe it would be unwise to extrapolate that trend,” says CLSA.

But many brokerages expect the trend to improve from here on.

 “Although this recovery is yet to be broadbased, earnings are on the path of improvement. Fundamentals are expected to improve on the back of improving macroeconomic factors with a consumption-led recovery, followed by public sector capex and improvement in external demand; benefits of reforms percolating to the ground level and a conducive inflation-interest rates environment. The India story has just begun and we have a long way to go,” says Prasanth Prabhakaran, Senior President & CEO, YES Securities (India).

Prabhakaran expects FPI flow to India to rise as and when earnings improve. Foreign investors would take a lot of comfort from the increase in the domestic liquidity pool, which can help them enter and exit the Indian market with minimal impact cost, he said.

Besides earnings revival, a lot would depend on the pace and extent of interest rate hikes abroad.

“Stability of the rupee and GDP growth rate would also influence FII flows,” says Deepak Jasani, Head of Retail Research, HDFC Securities.

Foreign investors look at India from a medium-to- long-term horizon and, thus, a 15-20 per cent earnings growth scenario would look attractive to them.

Nomura India in a recent note said it expects double-digit equity returns across China, Korea and India, primarily driven by strong earnings growth. India remains its preferred pick. It expects a 10-15 per cent return for Chinese equity indices, mid-double digit returns for Korea’s Kospi and 17 per cent equity return for India.

Despite the selloff in the past couple of months, including a Rs 5,900 crore outflow in December, FPIs ended up infusing Rs 51,000 crore into domestic equities in 2017.

A ratings upgrade by Moody’s and continued hope of a recovery in the coming quarters fuelled foreign buying, even though domestic flows remained the talk of the town .

“The market has shown resilience to corrections and patience towards muted earnings recovery. It is difficult to comprehend when this patience runs out. Nonetheless, with the Indian market valuation pegged at 17 times FY19E earnings, the downside is expected to be limited,” says Jayant Manglik of Religare Securities.

Data showed mutual funds infused Rs 1.2 lakh crore into domestic equities during 2017.

“Domestic flows will sustain and keep the market buoyant, foreign investors do not have a choice other than continuing to invest in India. But they need not be aggressive buyers since many EMs are relatively attractively valued and US yields are likely to harden,” VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services said.

Siddharth Sedani, Head & Vice President of Equity Advisory at Anand Rathi Financial Services, said the government and recent bank recapitalisation along with infrastructure spending will attract FPIs in 2018.

“There will be occasional hiccups in FPI flows, but generally we have been good recipients of foreign flow,” said Rakesh Tarway, Head of Research , Reliance Securities

In case of an abrupt increase in global interest rates, foreign flows are likely to suffer, said Tarway.