Two things have doubled over the past few months in the Indian capital market— investor’s wealth and their confidence in the country’s stock exchange. And why not? The rate at which the Indian stock markets has grown since the beginning of the year 2004 creating and crossing milestones, investors are quite upbeat about the markets and their money.

Not long ago, investors in the country’s premier Bombay Stock Exchange were ready to pull out as companies performed badly and two scams in a decade- the Harshad Mehta scam in 1992-93 and the Ketan Parekh saga in 2000-01 overwhelmed investors. They were losing money and every stockbroker was under the regulators scanner. In the past, India has often been a terrific hub to lose money. If one had invested in the Sensex in 1992, say, they’d be 30 percent poorer by 2004.

But those are the things of the past and the market today is vibrant, a fertile place to invest. Listed companies have been churning out good results quarter after quarter, increased interest of the Foreign Institutional Investors and government which is increasingly pouring money to develop basic infrastructure, health, education and agriculture has led to demand of Indian stocks. From the under 5000 mark this year the Indian market closed at an all time high of 8800 in early October.

“To begin with, clearly there is lot of activity happening, firstly with infrastructure which is still at a very nascent stage and cannot be compared with other countries. Things are moving in the right direction. Second is the large market size. A very broader demand base helping companies create capacity and in turn with more sales,” says Jay Sinha, Head, Equity Research, Kotak Investments, a Mumbai based financial conglomerate.
The demographic change has added punch to the market. Earlier most companies focused on the domestic market. It was an inbound approach. With the emergence of the large middle class, the entire scenario of telecom, housing, auto, insurance and banking has changed. With the heavy demand from the middle-class who have higher disposable income, the market has been pulled up. Still the penetration in these segments is terribly low when compared to the world standards.

“With a pathetic penetration and a dynamic demography, there has to be a match and that has resulted in exploding growth. Yes we have attracted a large part of domestic and foreign investors,” says Sinha.

Foreign Institutional Investors have developed a fancy for Indian stocks on a scale unparalleled in the last decade. The last couple of years have seen a 50-percent increase in the number of FIIs investing in India. FIIs that entered India in the 1990s reaped rich dividends, mainly in the sustained bull market from mid-2003. Those who joined the party in the last couple of years too have done quite well. And this is likely to augur well for Indian equities.

The experience of the new entrants like Fidelity Investments, and many others from Europe, Japan and Korea however, is in sharp contrast to that of their earlier counterparts. The new entrants, however, had an easier time, buoyed by wealth creation in the market, backed by robust fundamentals of India Inc. and a booming economy.

Indeed, this has raised FII interest in the country. In the past months, with a robust FII flow the equity prices have moved to historic highs; this is a mini turnaround of sorts as the FIIs were net sellers in April and May 2005. At $7 billion, the inflows are well on their way to best the $8.5 billion that poured into Indian equities in the year 2004 — about 25 percent in seasoned equity offerings and IPOs of several large-cap companies. In contrast, a larger proportion of inflows this year has gone into buying from the market.
On a comparable basis, FII inflows this year are already at record highs. It is now certain that, even in absolute terms, they will set new marks for the third year in a row in 2005. As the scale of the investment in India has risen manifold in recent years, the FIIs have invested in a larger number of stocks. They now have exposure in more than 500 companies. And this at a time when the economy has been notching up healthy growth rates and, more important, when Corporate India is in its best ever shape.

In terms of sector preferences, too, the FII portfolio is more diversified than at any time in the past. This, too, is a significant positive for the market.

Other factors that have helped the Indian stocks peak are the high return expectation. Companies’ are giving healthy return of 20 percent that will pull up the market. The appreciating rupee, and easy access to the large secondary market and the regulatory environment.

Other than the regulatory restriction, it is the overall tax framework. With short-term tax reduced to 10 percent while long-term tax abolished; it is a shot in the arm for overall equity investment. Elsewhere in the world one has to pay 30 percent tax, in India they don’t have to pay actually if FIIs hold for one year. This has given an unparalleled boost to the overall equity environment.

Business environment too has changed a lot since. “With higher metal and oil prices, which have continued better pricing, companies have been able to clear all dues and invest in expansion. Despite oil prices being higher and losses being absorbed by the companies, rest of the economy was insulated from this,” says Sinha.
Government backed thrust on infrastructure, agriculture, public health and education has created vast resources for all outsourcing companies. All things put together- there are corporate houses, and external factors that have helped the growth. There is the regulation and government support, which has been very positive. At both micro and macro level they are extremely favorable.

Though the companies can produce good results, one thing that can remove the sheen off of the Indian market is agriculture. If the economy has to sustain seven percent growth for a few years, then India has to reduce the volatility of agricultural produce. While the manufacturing sector is growing at 7-9 percent, it is agriculture that is bringing the market down.

“The government is looking at that at a very serious note. The government has asked the banks to increase credit to agricultural sector. All banks are meeting the requirement. If it concentrates on rural development, rural electrification, rural jobs creation- that will surely reduce the volatility and output will go forward,” Sinha sums up.