Look beyond the PaiN

Agreed, there could be pain in the short-term: the Sebi board meeting on October 25, could legalise the proposal to curtail the use of PNs, FIIs might withdraw a few billions in the next few days, and the Sensex could witness further correction. As Amar Ambani of India Infoline says, 8220;Past experiences in Malaysia and Thailand reveal the futility of capital controls. These measures might still not be effective in giving support to the dollar vis-agrave;-vis the rupee, but could potentially destabilise the market scenario, for the near term at least.8221;

But look beyond these near-term worries. 8220;As their capital markets deepen and economies grow, China and India have developed a taste for stocks, something we will not see replicated on such a scale again in our professional lifetime. Instead of running from Asian stock markets at the first sign of trouble, foreign investors are likely to allocate even more money to them, making them more expensive in the process,8221; said Mark Matthews and Willie Chan, strategists at Merrill Lynch. This being a strong possibility, some foreign players are expecting the Indian currency to appreciate further.

Why more allocation?

The growth is here. China and India are forecasted to have the strongest growth 8212; around 9-11 per cent over the next few years, while the regional average is slightly above 6 per cent. They are the largest economies, at 3,250 billion and 1,125 billion respectively. Elsewhere in the world, there is not much growth, a situation that does not appear likely to change. Merrill Lynch forecasts 1.4 per cent GDP growth for the US next year, 1.0 per cent for Japan and 2.3 per cent for Europe.

And it8217;s not 8220;India8217;s Warren Buffet8221;, Rakesh Jhunjhunwala, alone who says India is set to achieve double-digit growth in coming years. Signals from India Inc, which is in the midst of the quarterly earnings season, also confirm this. 8220;We judge that India could grow sustainably even faster than at present 8212; and faster than most other studies have suggested 8212; at 10 per cent per annum over the coming decade,8221; said a top official of Wall Street investment firm Lehman Brothers, who was in India last week.

The government might have its own reasons for moderating capital flows 8212; and the PN curbs may be questionable. But nobody has any doubts about the increasing transparency and higher inflows waiting to happen in future. 8220;Limiting the use of offshore derivatives will lead to a surge in terms of many funds/investors seeking FII status as India Inc8217;s growth momentum will keep inviting fresh capital,8221; said Manish Jain, vice president Investment Banking, Atherstone Capital Asia.

The quantity of inflow in the long term would depend on how many funds and investors are able to register themselves as FIIs. 8220;The number of investors and funds seeking registration would go up. Tighter controls on P-Notes, coupled with surge in FII registrations, will improve disclosure and transparency in the Indian market,8221; said Jain.

Is there a stock-market bubble in India which trades at over 22 times forward earnings? For example, is Reliance at 27x a bubble?

8220;It8217;s expensive yes, but their execution has been so good, and their cash flow is huge. A bubble is when a company that doesn8217;t make any money, trades at ridiculous valuations. Reliance has cash flow of 4.3 billion this year,8221; Merrill Lynch says.

Who will invest in the Indian market in coming years?

There are many waiting in the wings. For example, pension funds and insurance companies, which have traditionally hugged benchmarks, have missed out on the Asian markets, including India, so far this decade. At the same time, they have faced diminishing returns elsewhere.

8220;In an attempt to boost their returns, they have gravitated toward hedge funds. But investing in them is not without issues. Performance fee is high, and NAVs are not published on a regular basis. Now pension funds and insurance companies are getting interested, and looking for other vehicles to invest,8221; said a foreign investment firm.

Having said that, the rising inflows could pose problems on the liquidity management front. This means the regulators and the government would have to devise more mechanisms to absorb the flows. Slapping controls should be the last option. In this globalised era, foreign investors will go to a country where they can move funds without facing curbs, and make decent returns.

Finally, there could be more uncertainties down the line. Political fears, election issues, US turmoil and liquidity problems might haunt the markets and the economy. But the bottom line remains unchanged: the India story is intact.

FIIs and markets

8226; Foreign interest is growing. In India, FIIs own 21 of the market. In Taiwan, they own 32, in Korea 33, and in Thailand 36.

8226; Foreign pension funds and insurance companies have missed the boom here so far. They are looking for investments.

8226; More FII allocations to emerging markets like India likely.

8226; Valuations are high here, but are backed by corporate cash flows.