(The views expressed in this column are the authors own and do not represent those of Reuters) January

was a big disappointment to the stock market. The Sensex which had crossed the earlier peak was already down to 20,000 at the beginning of 2011. It gradually slumped further during the first three weeks and dropped with a thud towards the end of the month. There were reasons not all very apparent. The Sensex was undoubtedly hammered by the global trends. The Egyptian crisis meant not only a setback to some of the Indian companies operating in Middle East but also a sharp increase in commodity prices. Oil shot up to more than $100 a barrel. International prices of food products also jumped. That meant higher costs and lower profits. There were also fears that the Suez Canal could be closed. The domestic reasons were even more convincing. Inflation had relapsed. Food inflation crossed 17 percent and the headline inflation for December touched 8.5 percent. Besides, the many tales of widespread corruption had created doubts about effective governance. The RBI reacted to inflation the usual way. It put up the repo rate by 25 bps threatening at the same time that further action may follow. That was more than a cue to the banking sector which pushed up the interest rate on lending as also borrowing. Added to all this was the rather tame performance of the corporate sector in the last quarter of 2010. That was enough to knock down the Sensex. There is however more to it than that. For, the Sensex had started climbing down right from the beginning of the year and had lost 1,000 points by the middle of the month. That was because the FIIs had begun to repatriate part of their investment possibly because there were better opportunities at home. In January, even before the Egypt crisis, the FIIs disinvested more than $1 billion. That was because the US economy was on a rebound. A reflection of that was seen in the recovery of Dow Jones which crossed 12,000 on 27th January, a jump of 3 percent in three weeks. The US economy grew 3.2 percent in the last quarter of 2010. That was mainly because of the improvement in consumption which had stagnated

and will become the mainstay of recovery in future.

Interest rates have also been hardening and prices rising giving an indication that the US is on way to recovery though the Federal Reserve is still cautions mainly because unemployment is still above 9 percent. It therefore appears that about a half of the 2,000 points loss in Sensex in 2011 is due to US recovery which prompted return of FII funds. The month end events like the Egyptian crisis, crude oil prices, even domestic inflation, will be back to normal possibly in another 4-6 weeks. But the loss from return of FII funds may continue and put a lid on Sensex which will remain subdued for some time unless the budget provides a trigger.

The sharp pangs of distressing high inflation, weaker rupee, disappointing corporate results and FII selling pushed the markets back to its earlier range of 4700 5200. Further pressure was witnessed in the rupee which dipped to test 52 levels against the dollar the weakest since March 2009. Risk conditions on the global front continued to be negative in addition to lack of foreign fund flows in the stock market. Raising of foreign investment limits into India did not have any impact on the currency market as this measure would have worked only if there was FII interest in India. The Reserve Bank of India also appeared to be very cautious over intervening to support the rupee. Going forward, the trends will continue to be influenced by risk appetite. There are expectations that IIP might have grown between 5-5.5 pct y-o-y in August as against 3.3 pct y-o-y growth in July. WPI data for September is importance as it will indicate the Reserve Bank of Indias (RBI) likely monetary policy stance at the half-yearly review on October 25. The RBI has raised its key lending rate 12 times since March 2010 as it tries to bring down stubbornly high inflation. Policymakers expect inflation to start easing from November due to base effect kicking in, if not due to measures taken by RBI or good monsoons. Majority of market participants expect the RBI to hike rates one last time in its current tightening cycle in October. the sharp fall of the rupee in September is not because of inflation but the flight of FII investment. In two weeks, FII disinvested $1.5 billion, about half from equity and half from debt. The market which had already become very sensitive to fears about recession in the U.S. and the EU debt crisis, collapsed taking the rupee with it. The flight of FII investment was not restricted to India but extended to most other emerging market economies. That resulted in the strengthening of the dollar in spite of the imminent recession in the U.S. The dollar appreciated 7 percent against the euro.

fter their flight last year, foreign institutional investors flocked back to bet on the

India [ Images ] growth story by pouring in a record over Rs 80,000 crore (Rs 800 billion) in domestic equities in 2009. The FII investment of Rs 80,500 crore (Rs 805 billion) in 2009 is the highest ever inflow in the country in rupee terms in a single year and comes a year after they pulled out over Rs 50,000 crore (Rs 500 billion).

FII inflow so far this year has broken the previous high of Rs 71,486 crore (Rs 714.86 billion) parked by foreign fund houses in domestic equities in 2007. Market analysts believe that the FII inflow in India may continue in the next year as well, if the liquidity conditions remain strong. "FIIs will continue to be positive on our markets and in general Indian markets will fare well in 2010," Purpleline Investment Advisors director P K Agarwal said. Delhi-based SMC Capitals Ltd's Equity Head Jagannadham Thunuguntla echoed the view, saying, "If liquidity conditions remain strong next year, one can expect FII inflows to remain strong into India even in 2010 as well." During a year when the stock market barometer added over 70 per cent to its valuation, foreign institutional investors (FIIs) made a net investment of whopping over Rs 80,500 crore (about 16.8 billion dollars) in the Indian share market. The Bombay Stock Exchange's [ Images ] benchmark Sensex, comprising 30 bluechip stocks, has gained more than 70 per cent so far in 2009, one of the best performer among leading global bourses. "However, if dollar-carrytrade-unwinding starts, then one can expect rush of FII outflow from the country, resulting in pressure on Indian markets," he cautioned. Significantly, last year the FIIs had pulled out a net Rs 52,900 crore (Rs 529 billion) from the domestic bourses --a trend triggered with the collapse of global financial services icon Lehman Brothers in the middle of September 2008. This selling trend continued till the first two months of the passing year. However, with the sign of revival of economies, the trend turned positive during March and overseas investors started betting big on the domestic bourses. "As the liquidity conditions started improving after the governments across the world started putting in the stimulus packages, FIIs again tried to come back starting March 2009," Jagannadham explains. As they came back, even Indian markets staged big rally. Moreover, FIIs don't have many other choices but for coming and investing in the high growth economies of India and China, he added. The trend of strong FII inflows to the tune of Rs 31,000 crore (about 6.3 billion dollars) witnessed during April-June quarter gained further during the September quarter this year and the period witnessed an infusion of hefty Rs 34,313 crore (Rs 343.13 billion). So far in the December quarter, foreign fund houses have made a net investment of about Rs 22,000 crore (Rs 220 billion) in the stock market, amid a period that witnessed the Dubai [ Images ] debt crisis. Moreover, in the debt instruments, FIIs have made a net investment of about Rs 5,200 crore (1.1 billion dollars) so far in 2009, according to the market regulator Sebi data.

Interestingly, the whopping inflow by FIIs into the local stock markets has alarmed the government and other authorities concerned. The inflow has also made industry chambers like Assocham demanding a two-percentage point tax on FII funds, whereas the exporter body FIEO (Federation of Indian Export Organisations) demanded government intervention to contain the flow. According to the FIEO, the FII inflow had been making the rupee stronger against the American greenback, rendering the exports incompetent from price angle. Last month, the government said record investments in the equities market by FIIs was not a matter of concern, but it would act if it finds any distortions. "It (FII inflows) is not a matter of concern. We have a system of monitoring. Whenever we find that there are some distortions, we have the arrangement to counter them. Therefore, it is not disturbing," Finance Minister Pranab Mukherjee [ Images ] had said. However, describing the foreign capital inflows as the success story of India's recovery, Reserve Bank Deputy Governor Subir Gokarn recently said that the inflow should not be viewed as a threat at this point of time. "You could see them as a positive sign which is that they reflect increasing global confidence in Indian recovery," the newly appointed Gokarn had said. During the year, the number of registered FIIs increased by 114 to 1,708, while the tally of registered sub-accounts rose by 458 to 5,330, according to the Sebi data. Adopting a contrarian view, Mumbai-based stock broking house India Infoline expects domestic equities market to generate a return of over 30% in 2009. The prediction stems from three broad views - India is relatively better positioned for stronger and faster economic growth than rest of the world, a reversal of downward pressure on the rupee due to the turnaround in current account and sharp decline in cost of capital. According to India Infoline analysts, while corporate capex will likely take a long time to recover, public spending and infrastructure spending will hold up well. Even as cost of capital is rapidly coming off, domestic liquidity conditions have improved and thus credit availability should improve. The sharp declines in commodity prices have reduced the cost of building infrastructure by 15-25% across the board. Notwithstanding large declines expected in external trade, a deceleration in industrial and services sectors and the investment cycle, we believe India is well positioned to grow its GDP by at least 5-6% in 2009. Industrial growth too will likely revive more quickly, owing to large capacity additions in core sectors, especially those where growth is constrained by supply, the Infoline report said. Although India is still trading at a 20% premium to the MSCI EM index, this premium is lower than the average of 40% that it enjoyed over the past five and half years. Thus in a relative sense, Indian equities have been de-rated vis-a-vis emerging markets.

The brokerage believes, FII flows will be positive in 2009, led mainly by increased weights in emerging markets and global funds. Earnings growth momentum and macro data will be bad for the next few quarters, but markets will look for growth cues beyond the next 2-3 quarters, the India Infoline report said. The report states that earnings growth, except in commodities and select domestic cyclicals, will either be resilient or in most cases will likely be better than what markets are pricing in, especially from the third quarter of next fiscal. The brokerage has picked Tata Steel, Suzlon Energy, Bajaj Auto, ICICI Bank and DLF Ltd as the dark horses for 2009. India Infoline is overweight on financials and consumer staples sectors and underweight on IT and energy sectors.

Furthermore, the index of industrial production (IIP) fell by 5.1% for the month October, which was recorded as the worst fall since March 200