India remains a favourite for FIIs

Positive sentiment on expectations of a Modi-led NDA victory puts India ahead of other poll-bound emerging markets

Political risk has become an overarching theme for investors in Thailand, India and Indonesia, where general elections are due this year.

So far this year, foreign institutional investors (FIIs) have pumped in $1.3 billion in Indian markets. And, investor preference has shifted to cyclical stocks such as those in the capital goods, infrastructure and real estate, banking and consumer durables sectors.

Despite garnering a fair share of FII flows, India lags major emerging countries that go to the polls this year, on a year-to-date (YTD) basis. Despite the euphoria and the recent rally, the S&P BSE Sensex has gained 3.1 per cent (YTD). The Jakarta Composite (Indonesia) index has been the top performer, rising about five per cent YTD, data show.

However, analysts remain cautious on the road ahead for Indonesian markets. In a note, Richard Iley, chief Asia economist at BNP Paribas, warns, “Indonesia also faces electoral uncertainty in 2014 and a still souring growth-inflation trade-off. Foreign ownership of the bond market remains worryingly high, raising the risk of continued outflows. Slowing economic growth and IDR (rupiah) depreciation also challenge the fiscal arithmetic in Indonesia, with evidence of substantial deficit overshoot set to emerge in the midst of the election cycle.”

So, what’s keeping FIIs interested in India? Foreign inflows into the equity market appear to be chasing the prospect of a supposed game-changing victory for the Bharatiya Janata Party (BJP), with the party’s strong performance in recent state elections boosting these hopes, analysts say. Most believe a Narendra Modi-led National Democratic Alliance (NDA) victory is almost certain and, therefore, a positive sentiment is being built.

Rajesh Cheruvu, chief investment officer, RBS Private Banking, says: “Among countries such as Indonesia, Malaysia, Thailand, South Africa and Brazil that will vote to elect a new government in 2014, relative certainty of the outcome is higher among the Indian market.”

Tirthankar Patnaik, director (institutional research), Religare Capital Markets, says, “Stability in the rupee has also aided sentiment. The latest current account deficit data have seen foreign investors buy Indian equities more from a rupee perspective, adding beta stocks such as capital goods and consumer durables to their portfolio.”

Note of caution

Despite the overall positive sentiment, analysts caution markets could correct in case the election outcome throws up a hung Parliament or a Third Front-led government. Even if the NDA is voted to power, the rally could take a breather, as investors wait and assess how the economic policies and reform measures in India take shape. “Only the equity market’s worst case scenario of a non-Congress, non-BJP ‘Third Front’ government can, we think, upset the Indian equities applecart,” says Manishi Raychaudhuri, managing director and Asia-Pacific strategist at BNP Paribas Securities.

Cheruvu of RBS says the chances of a Third Front government at the Centre are less than 10 per cent. If the Nifty rises to 6,700-6,800 in the pre-election rally, he expects it to correct to 6,200-6,300 in case of a negative outcome.

Dilip Bhat, joint managing director, Prabhudas Lilladher Group, says, “A decisive mandate might see the Nifty at 6,800-7,000, though it would be significantly ahead of the fundamentals. The question is can these heady levels be sustained? My sense is no. Markets will remain vulnerable to significant corrections from those levels. On the other hand, if a decisive mandate is missing, the Nifty could dip to 5,500-levels.”

Motilal Oswal, chairman and managing director, Motilal Oswal Financial Services, says: “The chances of a Third Front government are very low. However, in case such a government comes to power, we will see a 10 per cent correction in the markets from current levels and FIIs will press the sell button on India. On the other hand, even if Narendra Modi comes to power, incremental buying by FIIs will slow, as they will wait and watch how policy decisions shape up. So, either way, the markets will see some correction for some time after the elections.”