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India’s Equity Rally Faces ‘Stiffest Test,’ Morgan Stanley Says

Indian stocks face their “stiffest test” as corruption scandals threaten to cap the world-beating rally that took the benchmark index to a record this month, according to Morgan Stanley.

Federal investigating agents yesterday arrested eight Indian bank and brokerage officials following a probe into bribes and improper loan disbursals. The agency has separately been examining the role of a former central government minister in the sale of phone permits for less than their market value.

India’s benchmark stock index has retreated 7.3 percent from a Nov. 5 record close as inflation in China, Europe’s debt crisis, skirmishes between North and South Korea and concern about the strength of U.S. growth roiled investor confidence. Asia’s second-fastest growing economy is seeking investment to help build infrastructure needed to lift almost half the population out of out of poverty.

“Everything that could go wrong appears to be going wrong,” Morgan Stanley analysts led by Ridham Desai wrote in a report today. “These events will cause the volatility in Indian equities to intensify.”

Foreign fund inflows have almost doubled this year to an all-time high on the expectation consumer spending will boost corporate earnings. Stocks on the main equity gauge are valued at 18.4 times estimated earnings after jumping 12 percent this year. The measure is the best performer and the most expensive among the ten biggest markets in the world.

‘Buy on Dip’

The Bombay Stock Exchange Sensitive Index, or Sensex, added 0.1 percent to 19,474.18 as of 2:32 p.m. local time after swinging between gains and losses at least 12 times. The measure yesterday dropped to its lowest level in two months.

“Investors who can stomach this volatility may do well by buying the ongoing dip,” the Morgan Stanley analysts wrote. “We do not think that the recent domestic events are likely to spread into a contagion, and if anything may actually turn out to be a positive.” The analysts didn’t name any companies or industries.

Ramachandran R. Nair, chief executive officer, of LIC Housing Finance Ltd. and seven bank and brokerage officials were arrested by the federal investigating agency yesterday. Goldman Sachs Group Inc. today put under review its “sell” rating on LIC Housing Finance, the home-loan lending arm of India’s largest insurer.

The probe into the alleged bribes and improper loan disbursals by financial institutions may lead to “some derating” of the public sector banking industry, Citigroup Inc. said in a note to investors today.

Prime Minister Manmohan Singh on Nov. 20 rejected allegations that he had delayed responding to calls to prosecute the minister who awarded the phone licenses and pledged to punish the guilty. Opposition parties have prevented discussion of legislation since the parliamentary session began Nov. 9, seeking an investigation into the allegations the sale of the permits at below-market rates may have cost the state $31 billion.

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