The Hindu Business Line : `Rupee under pressure; more FII exit likely'

A SECTION of the foreign broking firms expects further outflows from the Indian equity market as high growth and rising external deficit could put pressure on the rupee.

"High growth and rising external deficits should continue to put pressure on the rupee, which could in turn lead to self-reinforcing capital outflows from equity and cash markets, forcing the currency down further," broking firm UBS Securities said in a report released this week.

These firms say the FII flows are short-term and unstable. The views of several foreign broking firms come after the fall of more than 10 per cent in the benchmark BSE Sensex from an all-time high touched in the beginning of this month.

FII inflows, mainly driven by the advice of foreign broking firms operating in India, were the main factor for the bull run in the equity market in the last two and half years.

"India's `E(equity)' could be inflated due to a benign corporate investment cycle and strong global and domestic growth. As the investment cycle gathers pace and growth decelerates, earnings should normalise," said JM Morgan Stanley in a report released last week.

It said valuations look rich, with India trading at a 40 per cent premium to emerging market equities and a 6 per cent premium to world equities on current price earning ratio (P/E).

Due to the depreciation of the rupee against the US dollar, the FIIs have been net sellers this month. According to the Securities and Exchange Board of India figures, the FIIs were net sellers of equity worth more than Rs 2,250 crore this month.

JM Morgan Stanley said that Indian equities remained vulnerable to heightened volatility and a vicious sell-off as excess liquidity gets squeezed.

According to UBS, the Indian economy is now overheated. This view comes due to average real GDP growth of 8 per cent over the past eight quarters, compared to only 5.4 per cent in the preceding five years. Moreover, industrial and manufacturing growth is trending a full four percentage points higher than the post-1998 average. "This sounds wonderful — but in fact, it's a very mixed blessing. The reason is that by almost every available measure, Indian growth is now overheated," it added.

All the positive factors that pushed the stock prices in the last two and half years are unlikely to be repeated. "The virtuous cycle of strong flows, low rates, rising consumption, higher growth and strong corporate fundamentals will likely end," JM Morgan Stanley said.

The two things that can keep Indian equities from falling apart, according to JM Morgan Stanley, are the high level of foreign exchange reserves and the conservative corporate balance-sheets.

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