FIIs are overweight on India with few choices to park their money in emerging markets. This is making Indian stock valuations appear rich in comparison to other emerging markets but not against historical standards.
The strongest inflow of foreign capital into Indian equities in the last three years is being matched by domestic investments, as bank deposit rates continue to climb out of their pandemic trough. The Nifty rally since the beginning of the financial year is driven by robust corporate earnings on reviving consumer demand fed by bank lending and a downturn in the commodity cycle. This has offset weakness in global demand for sectors like IT and mining.
Valuations are stretched even more for mid and small caps that have rallied faster than the large caps. Froth has built up with no significant change in fundamentals in the mid- and small-cap segments, with one notable exception.
The most meteoric rise among mid caps has been captured by companies feeding the surge in government procurement for accelerated infrastructure buildup. Their financials have been transformed by the scale of procurement as well as improvement in payments. This is a direct fallout of GoI‘s capex push with a focus on reviving MSEs.
The rally on Indian bourses is being driven by liquidity from foreign and local investors and government spending. All three are transient forces. FIIs will rebalance their India exposure as growth emerges elsewhere among emerging markets. Households may throttle equity investments once fixed-income returns become attractive. Government capex is designed to subside with a revival of the private investment cycle. For now, though, Indian stocks are gaining from a confluence of all three factors. And will continue to do so in the near term.
