Foreign Funds Head for Dalal Street Exit

Overseas funds have soured on Indian equities since the beginning of August because of rich valuations and slower-than expected corporate earnings recovery, prompting them to look for opportunities elsewhere.

They've sold Indian stocks worth a net $2.66 billion between August 1 and the third week of September, making it the most that's been pulled out of any major emerging market that discloses portfolio flows during that period. The outflows exceeded those from major emerging markets such as South Korea, Taiwan, Indonesia and South Africa. Brazil has bounced back, with investment of $2.17 billion in the same period.

The Nifty and Sensex gained 21.9% and 20%, respectively, this year -among the best-performing emerging market indices. Analysts said some foreign investors, who have been betting on a corporate earnings recovery, lost patience and booked profits. Market strategists said poor earnings growth doesn't justify the steep climb in stock prices. Readjustments in corporate balance sheets as a result of the GST could squeeze the domestic economy further after gross domestic product growth fell to a three-year low of 5.7% in the June quarter as private investment remains a laggard.

Rising geopolitical tensions over North Korea have hastened outflows from emerging markets. Investors are also concerned that the unwinding of the US Federal Reserve balance sheet may lead to the dollar strengthening and a bigger exodus from emerging markets like India. On Friday, the Sensex and the Nifty posted their highest single-day loss in 2017 with the Nifty closing below 10,000.

Indian stocks are among the most expensive emerging market equities. The Sensex is trading at 20.55 times earnings estimates for the current financial year compared with 13.77 times for the MSCI Emerging Market Index.

Brazil's Bovespa index has risen 13.66% since the beginning of August until September 21, compared with the Nifty's 1.49% fall in the same period. But for purchases by domestic investors to the tune of Rs.25,500 crore since August 1, the fall in Indian stocks would have been sharper.

Equity strategists said stability in commodity prices may have also led to improving earnings expectations in other emerging markets including Russia, Indonesia, Malaysia and Brazil. They have seen the benefits of higher commodity prices leading to robust export growth. Earnings growth has returned to these markets, unlike India where export growth doesn't impact the overall market as much. Foreign investors are likely to remain net sellers and may continue to allocate funds to other emerging markets in the coming days.

Even though Indian benchmark indices have scaled new heights recently, a comparison of the Nifty's performance with that of other emerging market peers shows that the Indian index has underperformed the MSCI EM index, which is up 27.8% for the calendar year.

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