India likely to lose out in emerging markets race

Inflation, corporate results to prove decisive

Emerging markets are expected to continue with their upward climb over the next 12 months as well, but international investors are not as bullish on India, which is expected to stay flat or even dip marginally.

The Indian equity market rose almost 26 per cent in the last five months since May 17""when the markets hit a seven-month low""though still off the highs in the beginning of 2004.

In fact, it was one of the best performing emerging markets last year, with foreign fund inflows playing a big part in driving the market up. India received Rs 30,792 crore of net foreign fund inflows in 2003 and has received more than Rs 23,200 crore in calendar 2004 thus far.

Some market players said that global factors have dominated emerging market performance in 2004, adding that these markets are over-discounting a global slowdown, higher interest rates, and a China hard-landing.

A recent JP Morgan report says: "As we enter a lower but steady growth period in 2005, regional and country-specific factors will become much more influential."

Market sources said that with robust domestic demand, most emerging markets are likely to post strong gross domestic product growth numbers relative to growth in developed countries.

This, combined with improving capital management, should allow for positive earnings surprises, they added, on conditions on anonymity.

Adrian Mowat, chief equity strategist - Asia Pacific Strategy, JP Morgan said," We feel that the main macro-economic concern for India is inflation. The bond markets may weaken which will also impact equity markets. Corporate growth should be good but we are cautious on certain sectors."

The report on emerging market equity strategy says that the equities appear inexpensive relative to both emerging market bonds and US equities.

This should limit the downside risk and offers potential of a re-rating, as equity investors become more confident in the economic outlook.

JP Morgan expects the MSCI emerging market free (EMF) index to gain about 20 per cent over 12 months and is overweight on Brazil, Taiwan and Thailand. But it is underweight on India, China, Chile and South Korea.

Rajat Jain, chief investment Officer at Principal AMC said, "We do not see a P/E multiple rerating in 2005 and the market should grow in line with profit growth."

He added that India is correlated with other emerging markets but the correlation with developed markets is not strong. Hence, India adds value to the portfolio of a global investor by being a diversified country risk.

JP Morgan's Mowat added: "I am cautious on Indian IT as valuations relative to US and Asian tech stocks look stretched. I also remain cautious on consumer staples where competition continues to be intense.

Competition may also depress margins for auto stocks. We are positive on cement, infrastructure stocks and reflation plays (HDFC Bank and ICICI Bank).

Our index target may prove too conservative if local savers continue to shift from moneymarket and bond funds to growth funds, which have a large equity component.

Ajay Bagga, chief executive officer, Kotak Mahindra MF said, "Going forward, we expect strong corporate results over the next two quarters and ours is a demand-driven economy, insulated from China, and with a strong commodity cycle. We are also insulated from a global recession as only 9 per cent of our GDP is export-driven. Considering this, our equity market should perform as well as other emerging markets if not better."