FEBRUARY 21, 2012, 3:27 P.M. ET
Article from The World Street Journal
By SHEFALI ANAND
NEW DELHI—Indian stocks are among the best-performing in the world this year, but whether this rally has legs could depend on three key events next month.
India's benchmark Bombay Stock Exchange Sensitive Index has jumped 19% this year through Tuesday. The sharp gains this year follow the Sensex's slide of 25% in 2011. The rupee, too, has rebounded this year, climbing around 7% against the dollar, after a drop of about 18% last year that added to the losses for U.S. investors in the Indian stock market.
The Indian rally this year is largely due to a flood of money into the global financial system after the European Central Bank in December issued hundreds of billions of euros in three-year loans to banks at low interest rates. A lot of this money has found its way into risky investments globally, including stocks in emerging markets such as India, analysts say.
Foreign investors have poured nearly $5 billion into Indian stocks this year through Tuesday, compared with a pullout of $357 million in 2011, according to data from the Securities & Exchange Board of India.
Analysts say three events in March could play a key role in the market's performance going forward. State elections, the release of the federal budget, and a central-bank review of interest rates will offer signals on whether the government is likely to adopt policies desired by investors.
Many market participants have been taken aback by the speed and steepness of India's rally. Some now say the market may be getting ahead of itself.
"The economy and corporate sector have to play catch-up, and deliver in earnings, investment, expansion and risk appetite," Citigroup analysts said in a research note last week.
Over the last year, India's economic growth has slowed, thanks partly to a spate of interest-rate increases by the Reserve Bank of India to combat inflation. The economy is expected to register growth of 6.9% for the year to March 2012, the slowest rate in three years.
However, earlier this year the central bank signaled its intention to ease monetary policy, which has improved investors' mood. Economists are expecting the Reserve Bank to cut its key interest rate within months.
Still, several India-specific issues that had plagued stocks last year—the lack of economic overhauls, the lack of investments in infrastructure and the damping of business sentiment—haven't gone away just because of a turn of the calendar.
"The key issue for the Indian economy is to promote investments," says Mahesh Nandurkar, equity strategist at brokerage firm CLSA India Ltd. Mr. Nandurkar notes that no major Indian company has lately talked about investing in large business projects. "We need to get that confidence back," he says.
Analysts say the key to that lies with the government, which needs to be more proactive while being fiscally prudent.
"What would be encouraging is if the government shows more intent, passing bills or reforms," says Vinay Agarwal, senior analyst on the emerging-markets team at First State Investments, a unit of Commonwealth Bank of Australia.
Investors were disappointed when late last year the Indian government rolled back its decision to allow foreign multibrand retail stores, like Wal-Mart Stores Inc. and Tesco PLC, to set up shop in India. A reversal in this would be welcome.
They also want to see changes in India's 117-year-old land-acquisition law, which has been a major stumbling block to infrastructure development in India in recent years. A new land-acquisition bill was introduced in Parliament last year that, among other things, would make it easier for companies to buy land for industrial uses, but no headway has been made. The government's promised overhaul of India's tax regime, aimed at streamlining and increasing collections, has also been stalled in recent years.
Whether any of these initiatives will come about in the near future may depend on the key events in March.
On March 6, results of elections in five Indian states, including India's most populous state, Uttar Pradesh, will be announced. Many market participants are hoping the Congress party, which leads the coalition government in New Delhi, will be able to bolster its showing in Uttar Pradesh and other states. That could help strengthen the national government's position in New Delhi and embolden it to take the steps that investors want to see.
"A more stable, stronger, clear government at the center...sends a signal to foreigners that stuff is getting done," says Jon Thorn, co-founder of the $400 million India Capital Fund, based in Mauritius.
Investors are also looking for signals from India's federal budget, which will be announced March 16. Analysts hope the finance minister will take steps to rein in India's burgeoning fiscal deficit, by cutting back on subsidies and expenditures, and boosting revenues by overhauling the tax system.
A day before the budget news is released, the Reserve Bank will announce the results of its latest review of interest-rate policy, which also is likely to have an influence on investor sentiment. But analysts are divided on the likely outcome.
Some expect the bank to cut India's benchmark interest rate at this meeting, while others predict the Reserve Bank will wait for the government to show fiscal prudence in the budget, and for inflation—the central bank's primary concern—to fall further.
"Next month is entirely event-driven," says Mr. Thorn of India Capital, adding that this could cause stock volatility in the near term. In the longer term, however, he is optimistic. Despite the recent run-up, Mr. Thorn says the Indian market "is still cheaper than it usually is, historically."
--Khushita Vasant contributed to this article.
Write to Shefali Anand at shefali.anand@wsj.com
Article from The World Street Journal