Indian shares will underperform emerging market peers: Normura

MUMBAI: Indian shares will underperform emerging market peers in 2011 as higher inflation threatens to stifle economic growth and pricey valuations makes shares less attractive, said Ian Scott, global head of equity strategy, Nomura International.

“A combination of valuations, upward pressure on inflation, the need for monetary policy tightening, together with a hangover period in fund inflows, will act this year,” Londonbased Scott told ET on the sidelines of an investor conference organised by Nomura. Foreign investors have pulled out roughly $2.3 billion from India so far in 2011, dragging down the Sensex by over 10%, after pouring in about $29 billion in 2010.

Worries that stubbornly-high inflation, sparked by a jump in food prices, would force the Reserve Bank of India ( RBI )) to raise interest rates more aggressively and result in a economic and corporate earnings growth slowing triggered the exodus of foreign investors from India.

The Indian stock market is ‘hypersensitive’ to interest rate increases and inflationary pressures compared with its peers, Scott said. “If we look at a ranking of emerging markets and calculate how much each of the equity markets is responding to upward pressure on bond yields, it is seen that the Indian market comes out as the market with the highest sensitivity to movements in bond yields,” he said.

Higher stock valuation compared with other emerging markets has contributed to the flight of foreign money from the Indian market, as investors felt equities did not deserve the premium when the economy is showing signs of slowing down. “The Indian market’s valuation is still a substantial premium to the rest of the emerging markets and also to the Chinese market. That is quite unusual to see such a big gap in multiples ,” Scott said. India’s Sensex trades at 17.37 times estimated earnings while China trades at 14.09 times, according to Bloomberg.

Among other leading emerging markets, Brazil trades at 10.66 times and Russia at 7.41 times. Jim Walker, founder of Hong Kongbased research firm Asianomics, in a recent interview, did not agree with the argument that stock valuations of India are more expensive than that of China. “Valuations of some of China’s high-growth sectors such as manufacturing and consumer goods are much higher than that of India.

But, India has a better track record than China in return on equity ,” said Walker. Nomura’s Scott believes that rising oil price is not necessarily a barrier to good equity performance, as seen in 2007, when the stock market rally did not slow despite crude oil touching $130 a barrel. “Oil price above a $100 a barrel isn’t a constraint in itself, but investors are more concerned over the political environment that is causing oil price increases rather than the oil price increase itself,” he said.