The Indian equity market is a one-legged stool. The one leg standing is the FII community while the other two (domestic institutions and retail investors) are MIA (missing in action). FIIs have invested over $18.7 billion year to date while domestic institutions have sold almost $13 bn. Hence a mere net $6 bn has been responsible for taking the market to an all time high. In spite of the all the macro issues that we Indians witness in India, the FIIs continue be bullish on India. However its not a mystery why. India, believe it or not, remains still one of the most favoured emerging markets and is still the #1 pick among the BRICs nations by FIIs. After Japan, India has attracted the second highest amount of FII flows in Asia (China & Hong Kong don’t report flows).
Having said all that, India’s economic slowdown does remain an overhang. From an average 8-10% growth, we have come to a low 5% in FY13, which could further see a downside to 4.5% in FY14, and marginally recover in FY15. Growth remains weak, while inflationary pressures have risen, forcing the central bank to raise interest rates. The new RBI governor’s main focus is on the CPI, even though growth has faced collateral damage. While the primary sector is slowly recovering, the core sector remains weak, and consumption— the biggest growth driver in last few years—is no longer so sticky. We expect the RBI’s anti-inflationary stance to continue, with interest rates likely to remain high for now, at least until the first half of FY15.
The current account has seen the worst, and is on its way up, albeit driven by a weak macro. The external situation has improved meaningfully due to stronger export growth, and lower imports led by restriction-based measures on gold imports by the RBI. We expect the current account deficit to come off meaningfully from its record-high 4.8% of GDP in FY13 to 2.6% of GDP or $44 bn in FY14. Despite this positive comeback, the BoP remains a concern as capital flows have substantially fallen amidst huge inflows via FCNR (B) deposits. With increasing odds of a potential, albeit modest US taper, we do not expect the external sector to improve in the near-term, and remain cautious on India’s BoP and the INR, particularly after the RBI shut down the dollar window for OMCs.
History indicates that the INR and