June 2 (Bloomberg) -- Indian stocks will continue to lag behind emerging-market equities as rising borrowing costs and inflation squeeze profits, Morgan Stanley said.
Overseas investors may continue to remain net sellers of Indian equities this year, Jonathan Garner, the investment bank’s chief Asian and emerging-market equity strategist, told reporters in Mumbai yesterday. The strategist reduced his recommendation on Indian equities to “underweight” from “equal weight” in March.
The Bombay Stock Exchange Sensitive Index has fallen 9.8 percent this year as the Reserve Bank of India boosted interest rates to curb price increases. Stocks in the index trade at an average 14.9 times estimated profit. The MSCI Emerging Markets Index, which has risen 0.3 percent this year, trades at 10.9 times earnings, data compiled by Bloomberg show.
“The valuation relative is at a 35 percent premium to the rest of emerging markets,” Garner said. Valuations “have not moved lower in line with the deterioration in profitability.”
Rising consumer prices and a 37 percent gain in oil in the past year have forced the Reserve Bank of India to raise interest rates nine times in 15 months. About 33 percent of the companies in the Sensex reported profits that missed analysts’ forecasts in the three months ended in March, compared with less than a quarter that did so a year earlier. India relies on imports to meet three-quarters of its annual energy needs.
“Compared with China, India has got more than twice the negative sensitivity to higher oil prices,” Garner said. “At the same time as it gets affected adversely by oil prices, India has one of the biggest deficits on its trade account.”
Garner’s comments came a day after Morgan Stanley’s India analysts led by Ridham Desai forecast the Sensex to increase to 22,100 this year. Profit growth is “nearing a trough” and interest rates are “closer to the peak than before,” the analysts wrote in a report. The gauge dropped 0.6 percent to 18,494.18 at the 3:30 p.m. close today.
“We need to see this improvement in profitability which Ridham is expecting to start to improve,” Garner said. “I am a bit more skeptical than that.”
Citigroup Inc. analysts led by Aditya Narain trimmed their year-end Sensex forecast to 21,500 from an earlier prediction of 22,000, according to a report dated yesterday. Still, low economic growth expectations, high risk perceptions and a resulting moderation in valuations are “reasons to buy,” the report said.
Foreigners pulled 66.14 billion rupees ($1.5 billion) last month, the most in a year, according to data from the market regulator. They invested a net 72.1 billion rupees in April and 69 billion rupees in March.
Inflows from abroad reached a record $29.4 billion in 2010, making the Sensex the best performer among the world’s 10 biggest markets last year. The largest-ever outflow in 2008 led to the biggest annual slump of 52 percent.
“The only investor class that is selling shares is foreign institutional investors,” the analysts led by Morgan Stanley’s Desai wrote in their report two days ago. Share buybacks by companies are at an “all-time high” and local institutional and individual investors have been net buyers for four months, the note said.
“We remain buyers of Indian equities with a 12- to 18-month view,” the report said.
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