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Stockmarkets: Ready for the ride? - Views on News from Equitymaster
 
 
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  • Nov 8, 2005

    Stockmarkets: Ready for the ride?

    The stock market movements in the past one month must have given the chills to even the savviest of investors on Dalal Street, as they saw the value of their portfolios swing wildly! Fathom this, the Sensex lost almost 1,200 points (13%) in about 17 trading sessions in October 2005 and gained back 550 points (7%) in the last 5 trading sessions. Not surprising! This is because the stakes are now higher, as much bigger players have entered the Indian stock markets, which have the capacity to 'move' the markets. And these are called the Foreign Institutional Investors (popularly known as the Foreign Institutional Investors (FIIs).

    The chart below reveals the increasing attraction of India as an investment destination by FIIs. The number of registered FIIs with our stock market regulator, Securities and Exchange Board of India (SEBI), has increased from under 500 in January 2003 to 800+ as on date. However, the rise in FII inflows has been much more dramatic in relation to the growth in the number of registered FIIs. To put things in perspective, while the quantum of money invested by this community of investors in 2002 was a paltry US$ 740 m (at the then prevailing exchange rates), this shot up to US$ 6.6 bn (or US$ 6,600 m) in 2003 and further to US$ 8.5 bn in 2004. However, this did not stop here. FIIs had surpassed their entire 2004 investments until September 2005 (US$ 8.6 bn) before the correction set in. At the current juncture, the figure stands at US$ 7.8 bn, with two months remaining in the current calendar year.

    Until recently, there were many factors that supported the continued strong flow of FII money into the country. These included the large population base of India combined with a favourable demographic mix, which makes India a domestic-demand driven economy rather than dependant on the fate of other economies, which is the case with many other emerging economies. Then there was the fact that India is far more efficient than it was in the last 5 years, thanks to competition, restructuring and consolidation, which helped them improve productivity and efficiencies resulting in higher profitability. A significant decline in interest rates also helped to a great extent, as it benefited not only corporates, who shed their excess flab (read debt) but also consumers, as it provided them with the spending power owing to the advantage of access to low cost loans. Then there was talk of reforms, which would provide the country the much-needed impetus for growth. Also, other important factors that helped FII inflows were the weakening of the US dollar against the Indian Rupee from over Rs 48 to a dollar to about Rs 43 and falling US interest rates. These developments favoured investments out of dollar denominated assets.

    However, currently, while India continues to support the second largest population in the world (next only to China) whose potential strength cannot be underestimated, the fact is that interest rates have started to inch up, which would surely, albeit slowly, start to reflect in reduced spending power. Further, with much of the corporate restructuring having already taken place, the possibility of further improvement in efficiencies and productivity would stand reduced from hereon. On the reforms front, while these have definitely been initiated, the pace of the same has been somewhat disheartening. Further, the dollar-rupee trend (and also that of US interest rates) has now shown a sharp reversal on the back of the strong rebound in the US economy, which makes investments in dollar denominated assets advantageous.

    By pointing the above factors, we do not intend to indicate that things are turning for the worse now. These are just a few of the indicators that determine FII inflows. But the fact remains that Indian equities, though attractive, are now no longer clear 'value' plays. Though India continues to grow at a steady pace, the sustenance of FII inflows cannot be understated. That in turn is dependent on India's relative attractiveness compared to other emerging markets. Having said that, we continue to believe that India would continue to remain on the FII radar as one of the most promising countries from a long-term perspective.

    To conclude, considering the Indian stockmarkets' increased dependence on FIIs, the volatility in the Indian stockmarkets would surely remain high. However, investors need not get overly worried about FII inflows (or outflows) into the country, provided they have a long-term investment horizon. Instead, they need to realise that a fundamentally strong company will attract investors (FIIs or otherwise) over the long-term, once the true value of the company is understood. Let the fundamentals and value dictate investment decisions, not FII fund flows.

     

     

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