Markets: Exhibiting resilience…

Despite scaling up to the evasive five-figure mark, the markets (Sensex) have shown a fair amount of resilience to negative pressures on the indices over the last couple of sessions. Surplus liquidity in the markets, on the back of consistency in fund flows from domestic and foreign investors alike, has kept the indices buoyant and bouts of resurgence have been witnessed despite profit booking at higher levels. Here, we review some of the factors that have lent support to investor sentiments.

Fund inflows remain intact: Capital flows to India have remained steady during FY06 so far, led by foreign investment flows and external commercial borrowings. The net inflows more than doubled to US$ 19.5 bn during 1HFY06 from US$ 7.4 bn a year ago. Foreign direct investment (FDI) inflows into India during 1HFY06 were higher by 35% YoY (source: RBI). Net FDI into India picked up on the back of sustained growth in economic activity and positive investment climate, with inflows going into the manufacturing as well as the services sectors. Outward FDI remained on track, reflecting the appetite of Indian companies for global expansion in terms of markets and resources.

While the net cumulative FII inflows during the first half of FY06 amounted to US$ 5.1 bn (US$ 4.7 bn during the corresponding period of FY05), the number of registered FIIs increased from 685 at end of FY05 to 823 by 9mFY06 (source: SEBI). What is also a comforting factor is that unlike earlier, instead of having regionally concentrated origination, the FII base has been very diverse this time. Also, notwithstanding further firming up of international interest rates, demand for external commercial borrowings (ECBs) increased during 1HFY06 in consonance with the sustained pick-up in economic activity. Thus, the market buoyancy has not been hampered by liquidity constraints so far.

Forex comfort: During 1HFY06, the current account deficit was more than offset by the surplus in the capital account, resulting in an accretion to the foreign exchange reserves to the order of US$ 6.5 bn. India’s foreign exchange reserves stood at US$ 139.5 bn at the end of 9mFY06, with India holding the fifth-largest stock of reserves amongst the emerging market economies and the sixth-largest in the world. The basket-of-currencies’ overall management has also done away with the ‘liquidity risks’ associated with a country. Taking these factors into account, India’s foreign exchange reserves continue to be at a comfortable level consistent with the rate of growth, the share of the external sector in the economy and the size of risk-adjusted capital flows.

Well-hedged external debt: India’s total external debt registered an increase of 1.8% during 1HFY06 and stood at US$ 124 bn at the end of 1HFY06. The increase during the quarter primarily reflected higher recourse to commercial borrowing and export credit. The key external debt indicators reflect the growing sustainability of external debt of India. Although the ratio of short-term debt to foreign exchange reserves increased marginally during the 1HFY06, India’s forex reserves exceeded the external debt by US$ 18.7 bn, providing a cover of 115%. The share of concessional debt in total external debt also continued its declining trend, reflecting a gradual increase in non-concessional private debt. Nonetheless, the concessional debt continues to be a significant proportion of the total external debt, especially by international standards.

Inherent economic strength: Notwithstanding inflationary pressures and higher interest rates, the economy continued to grow at rates of over 8%, thus accelerating demand for consumer as well as capital goods. Better remunerations and a demographic shift are factors that are expected to fuel the growth engine over the longer term.

So far so good….
No doubt, the above factors deliver a certain degree of comfort with regards to the ‘India shining’ story. Nonetheless, when one tries to find a semblance of the same in the stock markets, one may get carried away by over-optimistic sentiments and invest in pricey stocks. It is here that one needs to keep in mind that while the going has been good so far, a correction in overheated markets is inevitable. We thus need to remind investors that while the long-term macro growth story is untarnished, investments need to be made by careful and well-researched selection. After all, safeguarding your investment is as important as multiplying it!

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