Goldman Sachs Says Sell India Stocks as Capital Outflows Deepen

India’s capital outflows deepened in July, spurring Goldman Sachs Group Inc. to recommend reducing stock holdings as central bank efforts to support the rupee threaten to worsen the nation’s economic slump.

Foreigners sold a net $2 billion of domestic debt last month through July 30, extending the record $5.4 billion withdrawal in June. The two-month outflow from stocks reached $2.8 billion, the most since the global financial crisis in November 2008, regulatory and exchange data compiled by Bloomberg show. Goldman Sachs cut its rating on the nation’s shares to underweight in a report dated July 31.

The rupee weakened 1.6 percent last month and reached a record low on July 8 amid concern that reduced stimulus by the U.S. Federal Reserve will make it harder for India to fund its current-account deficit. The nation’s central bank increased two of its policy rates on July 15 to stem the currency’s decline, prompting a record surge in three-month interbank borrowing costs. Higher interest rates may hurt the economy and cause more currency weakness, triggering a “vicious circle,” Credit Agricole CIB said in a report yesterday.

“Recent activity data has been sluggish with no signs of a pick up in investment demand,” wrote Sunil Koul, an analyst at Goldman Sachs in Hong Kong. “The external funding environment has also become challenging, causing RBI to tighten liquidity.”

Stocks Slide

The RBI raised its marginal standing facility and the bank rate to 10.25 percent from 8.25 percent. It also capped the amount banks can borrow in daily repurchase auctions at 0.5 percent of deposits and increased the daily balance requirement for lenders’ cash-reserve ratios to 99 percent from 70 percent.

The central bank held the repurchase rate at 7.25 percent on July 30, after saying the previous day that the currency has become its policy priority. The RBI cut its growth forecast for the economy to 5.5 percent for the year to March 2014 from 5.7 percent. The biggest risk to the economic outlook “stems from the external sector” and a current-account gap that remains above the sustainable level of 2.5 percent of GDP, it said.

Indian government bonds sank in July, with yield on the 7.16 percent notes due May 2023 increasing 75 basis points, the biggest monthly surge for benchmark 10-year rates since March 2009. The rate was at 8.42 percent on July 24, the highest since May 2012.

The S&P BSE Sensex slid 0.3 percent in July, extending June’s 1.8 percent drop, which was the biggest in four months. The gauge is valued at 14 times analysts’ earnings estimates for the next 12 months, compared with 10 times for the MSCI Emerging Markets Index.

While foreigners sold shares during the past two months, net inflows so far this year were $12.3 billion, according to data compiled by Bloomberg. That compares with $7.2 billion of withdrawals from South Korea and $2.5 billion from Thailand. India recorded about $25 billion of inflows last year.

“Very little foreign selling has occurred in Indian equities relative to the massive foreign inflows over the past few years,” Koul wrote. “We see increasing risk of a potential flow reversal.”

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