Mumbai: The sharp decline of India’s benchmark index, the Sensex, breaking a long-held trend of moving in lockstep with crude oil prices and the S&P 500 index, has surprised experts, who blame inflation and corruption concerns for the recent flight of overseas money.
After last year’s record investment in Indian stocks by foreign institutional investors (FIIs), markets elsewhere have looked more attractive, leading to the pullout.
The 30-share Bombay Stock Exchange bellwether started a steep rise in August to close on a record high of 21,005 points on 5 November. Since then, the correction has been equally dramatic, with the index falling to 18,008.15 on Friday.
The view that India’s stock market rises when global risk appetite advances doesn’t seem to hold good any longer. The S&P 500 has jumped 4% in 2011 compared with a fall of as much as 12% for the Sensex.
Data on monthly returns of the two indices show the Sensex has only thrice in the past decade fared worse than the S&P 500.
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Although an improved global growth outlook, uncertain even a few months ago, has favoured developed market equities over those in emerging markets, Indian gauges have ended in the red even as Asian peers rose, in an unusual de-coupling.
“We did not expect the Sensex to lag behind its peers so much,” said Sanjeev Patni, president, institutional equities, Prabhudas Lilladher. “Foreign investors...have stepped aside because of multiple concerns on India.”
“We are clearly in unusual times,” said Amit Nigam, senior fund manager at BNP Paribas Asset Management India Pvt. Ltd, which manages assets worth Rs 5,020.63 crore.
The relation of the Sensex to crude oil prices is also well documented. Experts say crude prices indicate fund flows and rising flows usually benefit India. This time it has been different—the index fell even as oil prices rose.
While the Sensex went up with crude prices in September and October, rising prices beyond a point worried Indian investors, as it implied greater costs and higher import and fuel subsidy bills.
“Flows to India did not rise even when crude prices rose, since crude prices near the $100 (Rs 4,560) level are not favourable to India,” said Ullal Ravindra Bhat, managing director of the Indian arm of Dalton Strategic Partnership Llp, a global fund registered as an FII in India.
FIIs, the key drivers of Indian markets, sold $1.3 billion worth of equities net of purchases in 2011, owing to governance concerns as well as unfavourable macroeconomic indicators. This led to a sharp correction in the bourses.
“The perception about India has changed as investors feel the entire governance structure is weak and the 8-9% growth rate of the economy can no longer be taken for granted,” said Bhat.
Delays in clearances for key projects and the slow pace of infrastructure projects are major worries as growth would be difficult to sustain if the capital expenditure cycle does not pick up.
“To drive an economy at a fast pace, you need sustained policy actions, which we clearly don’t see now,” said Raamdeo Agrawal, managing director of Motilal Oswal Financial Services Ltd.
Despite growing at the second fastest rate of 8.9% among major emerging economies, there are concerns on the local growth story. Rising food inflation and a spike in global commodity prices can crimp growth and Prime Minister Manmohan Singh said as much in a speech to government officials on Friday.
It would also raise the risk to earnings growth of Indian corporations as inputs costs go up and a rising interest rate cycle restricts demand.
Rising corruption charges and the resulting political stalemate have not helped.
Concerns over political and corporate governance have become heightened in recent times, according to a recent report by Nick Paulson-Ellis, head of the Indian arm of Spanish investment bank Espirito Santo. The number of media articles on the subject is more than twice the number in the period after earnings fraud at Satyam came to light in 2008, Paulson-Ellis said.
“Our analysis shows...the previous four periods of spikes in commentary on corruption were followed by a period of underperformance or muted performance of Indian versus emerging market equities,” he wrote in his note.
For now, investors are focusing on inflation and the budget session to sense where markets might be headed. If inflation rises further, so will interest rates, the Reserve Bank of India has indicated. The session could shape sentiment as it comes after a stalled winter session and the policy responses of a government under attack would be keenly watched.
Analysts say the Budget is likely to be populist with important state elections around the corner, but it could spring positive surprises because expectations are muted.
“If the budget session passes off well and there are indications to show that the reform agenda is on, we could see investors stepping in to buy as valuations are now fairly attractive,” said Nigam.
The Sensex now trades at 14.5 times its forward year earnings, in line with its historical average and down from the multiple of 17 at which it was trading in early November.
While analysts said there could be earnings downgrades in the next fiscal owing to rising cost pressures, so far the consensus earnings estimate of Sensex firms for fiscal 2012 remains unchanged in the Rs 1,250-60 range, according to Bloomberg data, indicating a profit growth of 20%.
Graphics by Ahmed Raza Khan/Mint
Ashwin Ramarathinam and Bloomberg contributed to this story.